Today’s business world has many choices for the new entrepreneur to decide from when forming a business. The choices are sole proprietorship, partnership, limited liability partnership, a limited liability company, a S corporation, a franchise, and a corporate form. Development of scenarios portraying each of these forms of business will aid the entrepreneur with deciding which form will be the best choice for the business.
“Sole proprietorship is the simplest form of business organization. The owner of the business the sole proprietor is the business” (Cheeseman, 2010 p.530) advantages to this form of business is that it is easy to form and does not cost much in regard to monetary allocation. The owner makes all the decisions and owns all of the business and its profits. Samantha is a young woman who wants to own her own business.
Sam’s Dragon Salts, a bath salt business. Sam operates the business out of her home, Sam is the owner of the business, and because she is the only owner the business is run as a sole proprietor that is, “:a business owned by only one person and operated for his or her profit” (Kauffman Foundation, 2007) . Sole proprietorship is the easiest to own and maintain requiring little to no paperwork or approvals to begin operation. Sam’s bath salt business has done well and orders are coming in faster then she can fill so Sam now has advanced her business to the point where she needs to take on a partner. Sam starts researching the different types of partnership forms available to assist her with taking her business to the next step.
Partnership “A partnership forms when two or more entities join together for a common business purpose. Two or more people, a person and a corporation, two corporations, or even two partnerships may form a partnership.” (Kaufman foundation, 2007 p.2). Sam is forming a partnership with her best friend Beth who, like Sam, is a sole proprietor of a homemade hand lotion business. After meeting and discussing things they both have decided to become partners in a business which they decide to name Dragon Scales Bath and Lotion. When deciding to form the partnership,
Sam and Beth, had to decide the type of partnership that their new business would become. Partnerships can be either general or limited. General partnerships are defined as “a voluntary association of two or more persons for carrying on a business as co-owners for profit. General partners are personally liable for the debts and obligations of the partnership.” (Cheeseman, 2010 p.534) In the formation of a general partnership, four criteria must be met. The partnership has to be (1) formed with association of two or more persons (2) carrying on a business (3) as co owners (4) for profit (Cheeseman, 2010 p.534). A general partnership can be formed with little to no formality and must be a co-ownership.
To prevent any problems from occurring in the partnership, it is important for Sam and Beth to have a partnership agreement. The partnership agreement may be written or oral and depending on what state Beth and Sam are living in, they may have to file a certificate of partnership with the government agency responsible for business formation rules and regulations. Sam and Beth realized as their partnership advanced that they needed to move the business from their homes to a building but did not have enough capital to attain a building. After much discussion and research they decided that they need to add investors in their business that converted their general partnership to a limited liability partnership.
Limited Liability partnership Limited Liability partnership have two types of partners (1) general partners who invest capital, manage the business, and are personally liable for partnership debts and (2) limited partners who invest capital but do not participate in management and are not personally liable for partnership debts beyond their capital contributions.(Cheeseman, 2010). The formation of this type of form of business does require formal and public disclosure and has to comply with requirements set up by the RULPA or other state statutes.
When forming this type of partnership Beth and Sam will need a certificate. This certificate must have to include the name of the limited partnership and the type of business this partnership will be. The certificate must show the address of the business and who will receive the formal legal notices regarding the business. Also included must be the name and business address of each general and limited partner, along with the date the limited partnership will dissolve. Lastly, the amounts contributed by each person and any future amounts that will be paid to each contributor must be listed.
Formation of the limited Liability partnership does not commence until all of the paperwork is filed with the state and county and must have the proper certificate kept current for as long as the limited partnership is in existence. Beth, Sam, and their limited partners are doing well in their business and it is continuing to grow and prosper. Beth and Sam feel confident enough to move more in the direction of becoming a corporation, but yet feel they are not yet definite on corporation formation so in doing research they decide that they would move the company toward the formation of a Limited Liability company (LLC)
Limited Liability Company A Limited Liability Company is neither a corporation nor a partnership. This type of business entity, when properly structured, is designed to combine the benefits of corporate liability protection with the pass through tax treatment and management flexibility of a partnership (Kaufamn, 2007). This being a newly formed form of business the laws are different from state to state and usually require that the business set this type of form up by seeking legal guidance before advancing the business to this level. This formation takes a little more than just the forming of it. They need to file an article of organization with the secretary of state.
Articles must be very detailed in regard to an operating agreement about how the business will operate, who shares in the profits and losses, how you will induct new members and treat members that are retiring or resigning. The owners, also called members, control this type of form of business. LLC’s require a certain number of members; this differs by state and are usually contoled by a manager. Sam and Beth need to determine who the manager will be, and how much authority the manager and members will have on decision-making. Advantages to this type of business formation over other types are that the liability of the members for debts is limited to the extent of their investment and that if one or the other owners wants to transfer ownership it requires the unanimous consent of all members unless the operating agreement is set up differently.
This is not the form of business, which you would set up if you plan on your business being around for many years to come. Sam and Beth both have children who now want to come into the business, in hopes of taking over the business when Sam or Beth retires. Sam and Beth want a little more affordability to borrow money hold property and legally do nearly anything that an individual can do and now want to offer stock to their employees and the public. At this point they want to incorporate the company and have less liability and more protection for their personal assets. Corporations usually all start the same the only difference between a corporation and an S corporation is how you want the corporation to be treated at tax time.
S Corporation S corporation stands for subchapter a form of a corporation. It is distinguished because it elects to be treated as if it were a partnership at tax time. What this means is that the corporation pays no tax and the profits pass through to the stockholder who pay income tax on what they receive. This corporation type has shares that represent ownership of the corporation, and a corporation can exist forever apart from its founders. Beth and Sam have decided that with their business growing and expanding that by incorporating they have more flexibility to acquire increase financial capital and allows them to complete their goals. With the added funds, they are now able to branch out into several states and franchise their business. Franchise
A franchise is established when one party licenses another party to use the franchisors trade name, trademarks; commercial symbols patents copyrights and other property in the distribution and selling of goods and services. Generally, the franchisor, and the franchisee establish themselves as separate corporations. Advantages to this form of business are that it allows new markets to be reached, allows the business to expand and grow, and allows the franchisee the advantage of acquiring the knowledge and resources of the franchiser yet running as an independent business with uniform product quality.
Beth and Sam enjoyed when their business was small. When their business was small, they had their hands in the actual preparation of their products. The business has grown, they have less hand- on of the actual manufacturing of their product, and because they have branched out into being an S corporation and into franchising, they now are more involved in the corporate world of business. Corporate Form
A corporation is a business or organization formed by a group of people, and it has rights and liabilities separate from those of the individuals involved. It may be a nonprofit organization, engaged in activities for the public good; a municipal corporation, such as a city or town; or a private corporation that has been organized to make a profit.
Conclusion The growing experience from sole proprietorship, to a corporation has been a long process with mistakes and triumphs. The journey came with many decisions regarding what legal form of business an entrepreneur should take. Sole proprietorship or incorporation each comes with their own share of legal liability and tax incentives and taxation problems. When starting a business the best advice is to seek legal representation and to seek knowledge a well-informed person is better able to understand and move their business forward, they know when to have their ducks in a row and when to row the boat to change.
References Cheeseman, H. R. (2010). Business Law: Legal Environment, Online Commerce, Business Ethics, and International Issues (seventh Ed.). Upper Saddle River, NJ: Prentice Hall. Kauffman Foundation, (2007). Six Forms of Doing Business. Retrieved from http://www.entrepreneurship.org