Starting a New Business: Corporation, LLC or Partnership?

When you are forming a new business, an ounce of prevention really is worth a pound of cure.

Abraham Lincoln once opined that “he who represents himself has a fool for a client.”

There are times when that holds true.

People frequently go it alone and turn to the Internet for forms and assistance when forming a company. Unfortunately, many of those DIYers wind up in my office with a mess on their hands. Forms obtained online may not conform to the requirements of a particular state. And, they frequently fail to address issues that develop when partners experience a falling out.

The personalized guidance of an attorney and accountant almost always proves invaluable. They will ensure that their clients understand the differences among different types of businesses …

Corporation

A corporation is a legal entity, separate from those who create it, that is created to conduct business. A corporation can be taxed and held legally liable for its actions. The key benefit of corporate status is avoidance of personal liability. While double taxation is sometimes mentioned as a drawback to incorporation, S corporations avoid that situation by allowing income or losses to be passed through on individual tax returns, similar to a partnership.

A corporation (Inc.) has the following:

• Articles of Incorporation
• Directors/Officers
• Shareholders
• Shareholder Agreement
• Stock
• S Election (if applicable)

Partnership

A partnership involves two or more people who agree to share in the profits or losses of a business. A partnership is not subject to taxes on profits — nor does it benefit from losses when making tax filings. Profits or losses are “passed through” to partners to report on their individual income tax returns. A primary concern may be liability. Each partner is personally liable for the financial obligations of the business. There are several types of partnerships: general (GP), limited (LP), limited liability (LLP), professional limited liability (PLLP).

A partnership has the following:

• Articles of Formation
• Partners (general or limited depending on the type of partnership)
• Partnership Agreement

Limited Liability Company

The limited liability company, as an option, has gained popularity because it allows owners to take advantage of the benefits of both the corporation and partnership forms of business. Profits and losses can be passed through to owners without taxation of the business itself, and owners are shielded from personal liability.

A limited liability company (LLC) has the following:

• Articles of Organization
• Members
• Managers/Managing Members
• Operating Agreement
• Membership Certificates

Areas to Consider Professional Advice

Attorneys and accountants also serve to ensure that their clients are mindful of important considerations in choosing which type of company to form …

Legal liability. Consideration must be given to whether the business lends itself to potential liability. If so, the owners can afford the risk of being held personally liable. That is, in case of a lawsuit or judgment against the business, no one can seize personal assets if the business is properly structured.

Tax implications. Are there opportunities to minimize taxation? Double taxation, a common disadvantage often associated with incorporation, can be avoided with S corporation status.

Cost of formation and ongoing administration. Tax advantages may not offer enough benefits to offset other costs of conducting business as a corporation.

Flexibility. It is important that ownership is structured to provide the necessary flexibility to meet the unique needs of a business as well as the personal needs of the owner(s), today and in the future.

Governing Documents

Governing documents including shareholder agreements, partnership agreements and operating agreements should, at a minimum, address the following questions …

• What is each owner’s investment?
• What are the responsibilities of each owner?
• If an owner becomes disabled, incapacitated or dies, what happens?
• Can owners have outside business interests?
• How are conflicts resolved?
• Who will manage the company?
• Can membership interests be sold to third parties?
• How will profits/losses be distributed?

Via these documents, potential difficulties are anticipated and addressed. I often tell clients caught up in the excitement that surrounds all new ventures that my role is to plan for the break-up, identify “what-if” scenarios and address possible future problems so as to avoid expensive litigation down the road.

When you are forming a new business, an ounce of prevention really is worth a pound of cure.