Forming a Corporation

Is forming a corporation right for your business? What is a corporation?

A corporation is a separate entity that operates independently from the person/ people who formed it. It even has the same legal rights as a person; it has it’s own social security number, it can own assets and it can sue people as well as be sued, it can even keep operating after you are long gone. Many entrepreneurs are attracted to forming a Corporation because of the benefit of limited liability. Having limited liability means that you only risk the money you put into the business, not your personal money or assets. This means if someone decides to sue your business, you personally will not be liable for any debts encountered assuming you didn‘t conduct any criminal or negligent acts. The money or assets will be taken from your corporation instead. If there’s not enough money and assets in the corporation to cover the costs then that’s too bad for the collector.

There are two types of corporations; C corporation and S Corporations. The main difference between the two is the way they are taxed. C corporations are subject to double taxation which can mean huge cuts in your profits. C corporations are taxed in the corporate level and after being distributed to the shareholders they are taxed again. S corporations are only taxed at the shareholder level.

Advantages

  • You can sell shares to raise money for your business
  • You can easily transfer ownership (by selling shares)
  • Limited Liability
  • Better fringe benefits

Disadvantages

  • Selling stocks means selling a percentage of ownership. For example if you sell 20% of the shares of stocks in your corporation, that stock holder will have 20% ownership of the corporation.
  • C Corporations are subject to double taxation
  • Increased paperwork
  • Forming a corporation is more complicated and expensive

Limited Partnership

A limited partnership is made up of two types of partners; general partner and limited partner. The general partner controls the business and makes all the decisions while a limited partner just invests money in the business. The profits will be shared between partners but losses and debts acquired by the business will be the responsibility of the general partner. The limited partner only risks loosing the amount he/she already put into the business. This form of business ownership can be useful if you want to keep control of your small business but need extra funds. However it also comes with a lot of complicated paperwork. Many entrepreneurs prefer other small business structures when starting a small business because this form of ownership can be quite complicated to set up.

Advantages

  • Limited Liability for the limited partner
  • General Partner has all the control
  • Can have unlimited number of owners (however if you have many limited partners it may be better to form a corporation since it offers more flexibility)

Disadvantages

  • General partner will be responsible for debts and obligations
  • Need to be in compliance with security laws
  • alot of paperwork to set up

Limited Liability Company- LLC

A Limited Liability Company also known as a LLC is a new form of business structure which was developed for entrepreneurs who want the limited liability benefit of a corporation with the tax benefits of a partnership. You can even think of it as the new hybrid of business structures. Like a corporation, Limited Liability Companies (LLCs) require shares, however owners are called members not shareholders. Unlike a C corporation it is not limited to just one class of stock and unlike a S corporation not all stock holders need to be US citizens. Since Limited Liability Companies (LLCs) is relatively new, its definition and treatment may vary from state to state. A few states require at least two owners to form a Limited Liability Company (LLC). Some states will tax Limited Liability companies as a corporation.

Advantages

  • Limited Liability
  • Taxed as a partnership (not in all states however)
  • Unlimited number of members allowed
  • Members can include individuals, corporations and other LLCs

Disadvantages

  • Some states do not allow one member Limited Liability companies
  • Businesses such as banks and insurance companies can not become Limited Liability companies.

General Partnership

You may decide to start a small business with one or more partners. In a general partnership you and your partner will be the co-owners of the small business. When starting a small business with a partner be sure to issue a Partnership Agreement. This agreement will state each partner’s rights and responsibilities. Include in the agreement how decisions will be made if the partners can not agree in a particular argument. Also include the portion of profits/ losses for each partner. For example one partner may invest more into the small business so they may have a larger percentage of the profits.

Keep in mind that you never know how people will react to the stress of running a small business. Your once best friend may turn into Medusa when faced with the overwhelming stress and challenges of starting a small business. Make sure your partner is as confident and motivated about your small business idea as you are. Enter a partnership agreement with only someone you trust. Remember you will be liable for any decisions made by your partner/ partners for your small business. For example if someone sues your small business due to a decision made by your partner you can be held liable as well. Communication is essential in a Partnership; don’t make any major decisions with out consulting with your partner.

Advantages

  • Share expenses and losses
  • Easy to set up
  • Two or more heads are better than one

Disadvantages

  • Can lead to disagreements
  • You are liable for decisions made by your partner
  • No limited liability, however a general partnership can be easily formed into a Limited Liability Partnership in the future
  • Your best friend can turn into Medusa

Sole Proprietorship

Sole Proprietorship is the most common form of business. In a sole proprietorship, only one individual runs the business. It is the easiest to set up, with the least amount of paperwork. Usually all you need to do is register with your state government by purchasing a business license. The most significant downside of operating a sole proprietorship is that you are responsible for all the debts your small business may face. Unlike a corporation, in a sole-proprietorship structure the law views you and your business as one. This means the financial debts of your small business is considered your financial debts. For example if someone decides to sue your business and there’s not enough money in your business to cover the costs, your own money and assets (such as your house) are in jeopardy. A good small business insurance policy can reduce lawsuit worries but make sure you have a thorough understanding of what your insurance policy covers.

Advantages

  • You have full control over your business- You are your own boss!
  • Easiest and least expensive to set up
  • Less paperwork to get started than corporations
  • You can receive tax breaks for some of your business expenses such as a home office and travel (If the purpose of travel was for business of course)

Disadvantages

  • You are fully responsible for your business debts. If something goes wrong with your business, you will have to pay.
  • It is often more difficult to raise money for a sole proprietorship
  • Selling a small business can be more complicated than selling a corporation since the business assets are involved.
  • After you pass away your small business will probably soon follow