What Is the Best Legal Structure for My Business
Congratulations! You’ve decided to start a new business. But what is the best legal structure for your business? Choosing the right structure is a crucial first step in starting a business. This guide will list the basic types of legal structures to choose from, and the inherent characteristics.
General Partnership (GP)Consist of two or more persons known as general partners.
Partners are individually liable for the obligations, conduct, and actions of the entity, including willful misconduct and/or recklessness. Thus, if the GP is sued, the person filing suit could go after your assets outside of the GP.
Does not require a formal undertaking (e.g., filing paperwork with the State)
Certain actions by the partners can automatically result in the formation of a GP.
Generally, includes a partnership agreement, defining the relationship between partners.
GP’s are treated as a pass-through tax entity whereby a partnership's profits and losses are allocated equally among the partners by default (unless otherwise indicated in the partnership agreement), and reported on each partner's individual tax return.
Limited Partnership (LP)Requires at least one general partner, and one limited partner.
Formation of an LP requires registration with the State. A partnership agreement is generally included with the formation of the entity.
The general partner is held responsible for the obligations, conduct, and actions of the entity, including willful misconduct and/or recklessness.
The limited partner is akin to a passive-investor. He/she is not involved in the day-to-day operations of the business and is generally not liable for the obligations, conduct, or actions of the entity. Thus, if the LP is sued, the person filing suit could not go after the limited partner's assets outside of the LP. One exception to this general rule is if the limited partner has been acting as a general partner (e.g., participates in the control of the business, and the day-to-day operations.)
LP's are treated as a pass-through tax entity whereby a partnership's profits and losses are allocated equally among the partners by default (unless otherwise indicated in the partnership agreement), and reported on each partner's individual tax return.
Limited Liability Company (LLC)Requires at least one member.
Formation of an LLC requires formal registration with the State. An LLC is formed via its articles of organization. The articles require four pieces of information: 1) the name of the LLC; 2) the street address of the registered LLC; 3) the name of the registered agent; 4) the latest date upon which the LLC is to dissolve, or a statement that the duration of the LLC is perpetual until dissolution.
A critical component to the LLC is the operating agreement. The operating agreement is not a public document and does not have to be filed with the state. The operating agreement can be tailored to suit the particular needs of the LLC. However, it is important to remember that the members will be held accountable to the operating agreement in any legal action between members. Accordingly, careful consideration is necessary prior to finalizing the operating agreement.
For single-member LLC's, you may consider using the default agreement provided by the state.
For a multi-member LLC, the operating agreement is similar in concept to a partnership agreement. The agreement typically outlines the relationship between the members including but not limited to ownership percentage, approval of major business decisions, and whether the LLC is member-managed or manager-managed.
One of the key benefits to forming an LLC is that it provides limited liability to all managers and members. Thus, in the event of a default or suit against the LLC, members cannot be held personally liable for the obligations and/or debts of the LLC. This is the critical difference between an LLC and a Partnership.
To properly maintain an LLC, a business entity report must be filed with the state on a biennial basis.
LLC's are generally treated as a pass-through tax entity whereby a partnership's profits and losses are allocated equally among the partners by default (unless otherwise indicated in the operating agreement), and reported on each partner's individual tax return. However, an LLC may elect to be taxed as a corporation, whereby the entity itself is taxed at the corporate level. Keep in mind, if the LLC elects to be taxed as a corporation, any distributions to members will still be subject to an individual tax. This is commonly referred to as "double taxation."
CorporationFormation of a corporation requires the following: 1) the corporation's name; 2) the corporation's address; 3) the corporation’s registered agent’s name and address; 4) the purpose of the corporation; 5) stock information and assignment, which includes the amount, class, and possible value of the shares; 6) articles of incorporation; 7) corporate by-laws; 8) appointment of at least one director; and 9) an organizational meeting.
A corporation is generally the most complex of entities to choose from but can provide significant benefits depending on the type of business you intend to create.
Specifically, a corporate structure provides advantages when it comes to access to capital, e.g., investors can purchase stock in the corporation, enabling the corporation to raise significant sums of capital. Additionally, a corporate structure offers the advantage of centralized management. While there may be hundreds or thousands of investors via stock, the management team and board of directors would retain close control of the day-to-day operations and overall growth strategy.
Like an LLC, shareholders (owners/investors) are limited in liability. Accordingly, shareholders are generally not held personally liable for the debts, obligations, and specific actions taken by corporate officers.
Maintaining a corporation requires detailed and consistent record keeping including meeting minutes, biennial business entity reporting, and other reporting requirements as required by the State.
Corporations are taxed as an individual entity, and therefore do not receive pass-through tax treatment. Salaries paid to employees of the corporation would be considered a business expense. However, any dividends paid out by the corporation would still be taxable. Additionally, employees that receive salaries would be subject to an individual tax rate.
DisclaimerThe information provided within this guide is for general information and educational purposes only. Information within this guide should not be considered legal advice. Accordingly, visitors should not take, or refrain from taking any legal action based on this guide without first consulting an attorney. The use or reliance of any information contained within this guide is solely at your own risk.