Small business structures
Published 5:00 pm Monday, August 31, 2009
One of the unexpected upsides of the high rate of unemployment nationwide is that more and more people are choosing to start their own businesses.
For people who are creating a business for the first time, the plentitude of choices can seem mind-boggling.
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Business Structures 101: Sole Proprietorship Cons: No legal distinction between business and owner. General Partnership Pros: Easy to form, can be useful for couples who are in business together. Cons: Partners have unlimited liability for their own and each other’s actions. Limited Liability Company (LLC) Pros: Affords owners more protection from lawsuits than sole proprietorship or general partnership. Cons: More expensive to form than simpler structures. Corporation Pros: The company is a legal entity separate from its owners. Cons: The most complex business structure, it generally requires legal help to set up property. |
Should that new business be a sole proprietorship, a partnership, an LLC or a corporation? And what do these terms mean?
CRBJ talked
with Michael Lainoff, state director of the Oregon Small Business Development Center Network, about business structure basics that every entrepreneur should know.
The Sole Proprietor
“The very easiest form of ownership is the sole proprietorship,” Lainoff said. “It’s easy and very inexpensive.”
Sole proprietorship can be a good choice for businesses being formed by one person. The advantage is they cost very little to start, and anyone can create a sole proprietorship by registering with the Oregon Secretary of State Corporation Division and paying a minimal fee.
“The disadvantage is that there is no legal distinction between the business and the person who formed the entity,” Lainoff said. “It’s basically unlimited liability [for the entrepreneur].”
Lainoff said sole proprietorship is best for businesses composed of one person where there is very little risk of lawsuit, such as a small home-based crafts business.
“The sole proprietorship is a dying breed mostly because our society has become so litigious,” he said. “It’s hard to think of any business that has zero liability to it.”
But Lainoff said it’s typical for businesses to evolve. They may start out in one business structure and change to another later.
“As they get more complex with more assets at risk, they choose a more complex form of ownership,” he said.
The General Partnership
The general partnership is the next step on the business structure ladder in terms of complexity. It involves at least two people who have joined forces to create a business.
“The general partnership is easy to form,” said Lainoff, adding that usually a partnership agreement is required. “About the only time you wouldn’t need [an agreement] is if you are a married couple who have a defacto partnership.”
But the general partnership has a significant Achilles heel that is worth noting – the business structure has the same disadvantages as a sole proprietorship, and in fact can create even more liability.
“Partners have unlimited liability for each others’ actions,” Lainoff said. “Partner A signs an agreement and Partner B is held to it, even though they didn’t sign it.”
In terms of taxes, sole proprietorships and general partnerships are somewhat easy to manage, and people with basic bookkeeping skills may be able to manage a tax return for these business models.
Limited Liability Company
The limited liability company, or LLC, affords business owners more protection from lawsuits than the sole proprietorship or general partnership structures.
“The LLC is fairly new and a little more difficult to form,” Lainoff said.
Owners of an LLC are required to have a mutual agreement or article on file with the state; one person can legally form an LLC.
Fees to register an LLC are more expensive than for the sole proprietorship or general partnership, and the business model is more involved.
“It’s taxed like a partnership but you do have some legal distinctions between personal and business assets,” he said.
The Corporation
Next in the business structure hierarchy is the corporation. According to the Corporation Division Web site, a corporation is a legal entity owned by its shareholders. It exists separately from its owners, and continues to exist even when owners change. Like a person, a corporation must file tax returns, may own property, and may sue and be sued.
A corporation is managed by a board of directors. The three common types of corporations filed in Oregon are business corporations, non-profit corporations and professional corporations.
Corporations formed under Oregon law are domestic corporations. Corporations formed under the laws of other states but doing business in Oregon are considered “foreign” corporations.
“In any corporation it’s a little more complex,” Lainoff said. “Business owners become employees of the corporation, and there are tax advantages.”
There are also different types of structures referred to as S or C corporations.
“The distinction between S and C corporations is in taxes,” Lainoff said. “And an S or C can raise money by issuing stock to stockholders.”
Lainoff said it’s important to adequately protect the assets of the business owner and the business.
That’s why he recommends that when entrepreneurs progress beyond the simple sole proprietorship, they should consult an accountant or attorney to help decide the most effective business structure and set it up properly.
“When it comes to these forms of ownership,” Lainoff said. “It all boils down to simplicity and liability.”
New business owners can register their businesses online with the state at the Oregon Secretary of State Corporation Division, at www. filinginoregon.com. In Washington, visit the state government Web site at http://access.wa.gov/business/start.aspx.
These sites and the U.S. Small Business Administration, at www.sba.gov, are good sources of additional information on different business structures.
