Partnerships, LLC’s, and Corporations: What’s The Best Option For Your Business?
Ever wonder what the difference is between a sole proprietorship, partnership, LLC, and a corporation? Well, if you own a business or are about to start one, you need to know.
Having said that, here’s the scenario:
You’ve been thinking for some time now about starting your own construction business. The problem, however, is that you have no idea where to start. Friends, family members, neighbors…they’ve all given you advise on what to do, but their advise has done nothing more than left you confused and depressed.
“You need to set up a corporation.” “A partnership would be the safest bet.” “You’ve lost your mind if you don’t start an LLC.” These are just some of the pieces of unwanted “advise” you’ve been getting.
You’re at your breaking point with all of this. If you don’t get some solid and trusted advise from somebody, you may give up. What can you/should you do?
Well, let me first say….DON’T GIVE UP!!!
Figuring out how to set up your business is really not that bad. Plus, there are already some great websites that have all the forms you need to start your business. Here’s what you need to know:
Lets begin with a few definitions:
- Sole Proprietorship: This is business that has one, single, solitary owner.
- Partnership: An association of two or more persons to carry on as co-owners a business for profit (Revised Uniform Partnership Act, “R.U.P.A.).
- LLC (Limited Liability Company): An entity eligible to be taxed like a partnership while offering its owners (called “members”) the limited liability that shareholders of a corporation enjoy.
- Corporation: A company or group of persons authorized to act as a single, legal entity.
Now that we have the general definitions, lets get down to the specifics.
Sole Proprietorship: This type of business is exactly like it sounds. It is owned and operated by one person, the proprietor. There is typically no protection against personal liability in a sole proprietorship (meaning that the owner could be held personally liable should someone file a lawsuit). To form one, you generally just have to apply for the proper permits and/or licenses required by state and local law.
Partnership: This type of business is fairly common. There will be two or more persons or entities (i.e., another LLC or Corp. for example) involved in a partnership. Each person/entity will typically have equal ownership rights in the business.
There aren’t really any specifics as to the formation of a partnership. A partnership is formed as soon as two or more persons/entities associate to carry on as co-owners a business for profit. But this doesn’t mean there aren’t rules.
A partnership can be governed in one of two ways (generally). The most common and smartest way to govern a partnership is through a partnership agreement. This is the document that sets out the rules and terms of the relationship.
However, many states have something similar to the R.U.P.A. (Revised Uniform Partnership Act). Generally, the R.U.P.A. provides a “default” set of rules. Many of those rules can be overridden by the terms of the partnership agreement. Many can not. Speak with your local attorney to help you figure out the best options for you.
But the important thing to remember is, just like the sole proprietorship, partners in a partnership can potentially be held personally liable should someone file a lawsuit.
LLC: The LLC, or Limited Liability Company, is similar to a partnership in many ways. However, the biggest difference is the “limited liability’ part. The owners/members of an LLC are generally protected from personal liability. This means that if someone sues the LLC and wins, you as a member cannot be held personally liable.
Now, this is not absolute protection from personal liability. There is a doctrine called “piercing the LLC veil” that can open up an owner/member to personal liability. But there are only a few and very specific situations that would allow a court to hold you personally liable.
To form an LLC all you have to do is file a certificate of organization (or, in some states, articles of organization) with the secretary of state’s office. Additionally, an LLC must have at least one member.
Corporation: A corporation is similar to an LLC in many ways. The biggest similarity between the two is that corporations also enjoy limited liability. This means that the officers and other members can’t be held personally liable (unless the doctrine of ‘piercing the corporate veil” applies).
To form a corporation, one or more “incorporators” file a charter with the secretary of state’s office. An incorporator may be any person or entity and need not be a promotor (i.e. a person who, before incorporation, seeks other interest parties, makes business arrangements for the corporation to be formed, etc.) or other person expected to be involved in the business itself.
So, let’s go back to the fact pattern above:
When I’m advising clients on the best “type” of business to set up, I have to consider the likelihood of being sued. This is a VERY important consideration (in my humble opinion). If we’re talking about a construction business, like the one in the fact pattern above, the best option is probably either an LLC (or something similar like an LLP (“Limited Liability Partnership”)) or a corporation.
This is because a construction business can have a pretty high risk of being involved in a lawsuit. Poor construction, injuries, breach of contract, etc. The owner(s) of a construction business have to be very careful to protect themselves from liability.
On the other hand, if the risk of being sued is low in a particular business (i.e. a clothing store or local coffee shop), then the protection against personal liability isn’t a major concern. Thus, the owner of a “low risk” business can generally choose what he/she wants.
I think it’s important to note that this post about business “types” is from a purely legal standpoint (i.e. formation, liability, etc.). Also, this post (like most of my posts) is a general summary of these topics. There are ALWAYS other considerations to keep in mind. Most importantly, there are tax considerations that have to be dealt with.
If you want to know more about the tax implications of starting a particular business. I would recommend speaking with an experienced accountant or tax attorney for advise.
So that’s the basics on starting up a business. It’s really not that bad. All it takes is a bit of time and thought and a little help from an attorney and you’re own your way.
Good Legal Health.
The Juris Doctor