When starting or expanding a business, many owners wonder if they should form a business entity and, if so, which one they should use. There’s a huge selection of information and»pitches» being made on the Internet regarding the benefits of certain entities versus others. When you cut through the flak, however, the principal reason for forming a business entity is to create protection from personal liability arising from your business activities.
It’s well established that up to eighty percent of businesses will fail in their first two decades. A number of these businesses, and probably yours, carry a high level of personal risk for their owners. If you’re not using the correct entity for your particular business, you’re going to be personally liable if the company fails. Would you like to expose your home, car and other assets? How about the assets owned by your spouse or their paycheck from a regular job? Selecting the correct entity for your business prevents such nightmares from occurring. More importantly, you can sleep at night knowing that the worst thing that can happen is losing your investment in the company, not your property.
There are a number of business structure options that exist in the modern corporate world. Following is a brief explanation of the most common business structures.
Corporations come in two basic types, a»C» corporation and an»S» corporation. There are various differences, but the central one is a tax issue. Briefly put,»C» corporations are taxed on their revenues and you are then taxed separately on any money you take from the corporation. An «S» corporation «passes through» all taxes to the shareholders with the information being reported on your personal tax returns.
Whatever the tax classification, a corporation is considered an independent entity from a legal standpoint. This independent status acts as a shield between the actions of the company and your personal assets. As a practical example, Kmart recently filed bankruptcy. The individual shareholders weren’t required to file bankruptcy and lost nothing more than their investment in the stock of the business. Forming and using a corporation for your business activities will have the identical effect, to wit, your personal assets won’t be wiped out if the company fails.
Limited Liability Company
A limited liability company, or»LLC» as it’s better known, was a really common entity choice in the early 1990s. LLCs are like corporations, but may be taxed as a partnership. In California, the LLC could have one owner or two. Irrespective of the amount, these owners carry the legal name of»member» The LLC provides a shield for your own personal assets just like a business.
In my view, it’s far better to have died a kid then maintain a partnership. Unfortunately, many small business owners form partnerships and do not even know it. This happens when they go into business with someone else. If no business entity is formed, the law considers that the business to be a venture and treats it accordingly.
Partnerships are harmful for one main reason: a partnership doesn’t offer any protection from liability and, in many ways, invites private liability. Under well-established law, most partnerships are categorized as»general». This simply means that each of the partners are contributing to the administration and functioning of the venture business. This classification can have gruesome results.
In a general partnership, each partner is jointly liable for the debts of any other spouse arising from the company. As an example, you and your spouse go to a company dinner with a client. Your spouse has a drink and then a couple more. Then they get into an accident on the way home. All the partners is liable for the damages claimed by the injured folks. That means YOU! Even if you weren’t in the vehicle, did not let the vehicle, never saw the vehicle and do not drink!
Partnerships are a recipe for failure. Stay away from them whenever possible.
Limited Partnerships [«LP»] are possibly the most misunderstood business thing. A limited partnership is like a general partnership, but allows some of the partners to limit their liability by being limited partners. It’s vital to remember that these limited partners are limited to only making a capital [money, content, gear ] contribution to the venture. They can’t be involved in actively running the business. If they’re, they lose any protection from partnership debts. Many limited partnerships end disastrously. If you’re married to the concept of pursuing a limited partnership, you have to do so in conjunction with corporations. That specific approach is well beyond the scope of this report, but don’t hesitate to contact me should you would like to follow a limited partnership.
Business owners must protect themselves by forming things for their business activities. The actual issue is identifying the arrangement that’s ideal for your specific situation.