Invest In My Idea

Finally, get some work references and make some phone calls. Deciding to partner with someone is one of the most important decisions you can make in your small business, so don’t skimp on the homework. As far as the costs go, the licensing and permits are fairly insignificant. The main cost is hiring a business lawyer to draft the partnership agreement. That can run anywhere from $1,000 to $2,500.

Limited Partnerships

There are two classes of partnerships: general partnerships (discussed above) and limited partnerships. In a general partnership, all partners are equal. Each partner has equal power to incur obligations on behalf of the partnership, and each partner has unlimited liability for the debts of that partnership. Because not all partnerships require that the partners have equal power and liabilities, some partnerships decide to form as a limited partnership instead.

In a limited partnership, there is usually only one general partner (although there could be more). The other partners are called limited partners, hence the name limited partnership. In a limited partnership, the general partner or partners have full management responsibility and control of the partnership business on a daytoday basis. The general partner runs the show and makes the decisions. A limited partner cannot incur obligations on behalf of the partnership and does not participate in the daily operations and management of the partnership. In fact, the participation of a limited partner in the partnership is usually nothing more than initially contributing capital and hopefully later receiving a proportionate share of the profits. A limited partner is essentially a passive investor.

While the general partner has all of the power, he or she also has the lion’s share of the liability. A limited partner’s liability is capped at the amount of his or her financial contribution to the partnership. Should the truck of a limited partnership kill someone accidentally, the damaged party could go after the general partner’s personal assets, but would be limited to the limited partner’s capital contribution.

 Thus, the main advantage to this business entity is that it allows the general partner the freedom to run the business without interference, and gives the limited partners diminished liability if things go wrong. Although a limited partner may seek to be more involved in the daytoday operations of the partnership, he or she does so at some risk. If he or she does participate more, it is altogether possible that he or she may be viewed as a general partner in the eyes of the law, with its attendant liability risks.

Another key benefit of the limited partnership is that it pays no income tax. Income and losses are attributed proportionally to each partner and accounted for on their respective tax returns. Because of this flowthrough tax treatment, a limited partnership is often the structure of choice for real estate ventures and investment securities groups.

If you do decide to start your business as a limited partnership, have your partnership agreement drafted by an attorney. Again, the costs will likely run between $1,000 and $2,500. You might also want to read Let’s Go Into Business Together: 8 Secrets to Successful Business Partnering by Azriela Jaffe.

Incorporating

The best thing about forming your business as a corporation is that it limits your personal liability, which is not true for partnerships and sole proprietorships. For example, say that you owned a tire shop and one of your employees negligently installed a tire that fell off a car and caused a threecar accident with several personal injuries. If your tire store was not a corporation, the injured parties could come after you personally for monetary damages. This means that you could lose your business, your house—everything. That would not be true if you incorporated. Creditors are limited to the assets of the corporation only for payment and may not collect directly from the shareholders.

There are several types of corporations including limited liability companies, closely held corporations, professional corporations, and S and C corporations.

• The corporation limits one’s personal liability.

• The corporation is a separate legal entity. It has its own tax identification number and is its own legal entity, separate and apart from the owners.

• Sole proprietorship and partnerships normally end upon death, disability, bankruptcy, or retirement of the proprietor or a partner. Corporations, being a separate legal entity, do not cease to exist when one of the founding members leaves.

• As the corporation grows, management and ownership can be separated so that the business can continue and the owners can still reap benefits. However, they may choose not to run the corporation.

• An important corporate characteristic is the ability to consolidate, merge, or buy other corporations.

• You may be taken more seriously by others if you have a corporation.

• Corporate stock may be freely transferred by sale or gift.

• A corporation can buy and sell property in the corporate name.

• A corporation can contract with the government, whereas most other business entities cannot.

• A corporation has numerous tax advantages, including pension and profitsharing options, and the election of S corporation status (see the following section).

Cons

• It is expensive to create and, depending on the situation, to maintain. Incorporating may cost $1,000 to $10,000, depending on the type and complexity.

• Majority shareholders can overpower minority shareholders.

• The shareholders, as owners, have little say in daytoday operations.

• A corporation is subject to greater governmental regulation and control than other types of business entities.

Limited liability companies (or LLCs) combine many of the advantages of a corporation and a partnership without the disadvantages. The LLC is a fairly recent business entity that may offer greater business and tax advantages than a regular corporation, while also offering better business and structuring advantages than a partnership.

Like a corporation, an LLC provides the limited personal liability that is so attractive in corporations, along with being a separate legal entity that can sue and be sued as well as buy and own property. Similar to a corporation, articles of incorporation must be filed with the state, and a registered agent must be named for service of process. Like a partnership, shares in the LLC cannot be transferred without the approval of all other members of the LLC.

The death, retirement, expulsion, or bankruptcy of one member does not end the LLC. If all of the remaining members agree, the LLC can continue and, in a few states, the law allows the business to continue with the consent of fewer than all the remaining members.

Closely Held Corporations

Allowed in some states, a close corporation is one whose shares are owned by only a few shareholders. Although there is no specific number, Delaware corporate law states that a close corporation cannot have more than 30 shareholders. Less than 15 is more typical. The purpose of a close corporation is to keep ownership and control within a small group of shareholders who have the same goals.

In a close corporation, distinctions between directors, officers, and shareholders are normally absent as the few owners own and operate the corporation without formalities. Unlike publicly held corporations, a closely held corporation’s shares are not traded on the open market.

The advantages to doing business this way are that

• shareholders can be restricted, and

• all shareholders can participate in the business.

The downside is that a few shareholders who disagree with the majority are generally out of luck as they cannot freely sell their shares.

This is a certain type of corporation that is designed for professionally licensed entrepreneurs only, and that professional can be the only shareholder. The type of professional that can take part in this plan varies by state, but usually includes doctors, lawyers, dentists, psychologists, and accountants. Note though that a corporation cannot normally shield you from a malpractice award.

S and C Corporations

S corporations are intended for smaller enterprises. Like an LLC, S corporations are informal enough to allow you to run your business like a sole proprietorship or partnership, while giving you the protection of the corporate shield; that is, limited personal liability.

A big disadvantage of regular corporations (or C corporations as they are legally known) is that they are taxed twice—once when profits are realized, and a second time when those profits are passed on to the shareholders. The advantage of the S corporation is that it avoids this double taxation and profits are only taxed once. In fact, S corporations do not pay a corporate tax at all. Instead, their shareholders report profits and losses on their personal tax returns. The advantages of S corporations are obvious, but be aware that there are restrictions:

• An S corporation can have no more than 75 shareholders.

• All shareholders must be citizens or residents of the United States.

• The corporation’s tax year must end on December 31.

• It can only have common stock outstanding (as opposed to preferred stock).

• The corporation cannot earn more than 25 percent of its gross income from passive investments such as interest, dividends, royalties, and rents.

To create an S corporation, you must first file the necessary articles of incorporation with your secretary of state’s office. You then need to file a Form 2553 with the IRS. This is a fairly complicated matter so it is best to hire qualified legal counsel.

Which is best for you? If you plan on creating a large company (one that is publicly traded), you should choose a C corporation because shares of stock are most easily bought or sold. While you might want an S corporation for tax reasons, it is limited to no more than 75 shareholders, all of whom must be individuals, and that is sometimes a problem. LLC’s trump S corporations because they have no limit on the number of shareholders, and those shareholders can be corporations and partnerships. Generally speaking, LLC’s are best for smaller startups and C corporations are best for larger ones.

Licenses and Permits

There are some bureaucratic hoops still to jump through before you open your business. If you are going to operate a sole proprietorship or partnership using a name different from your personal name, you are probably required by your city, county, or state to register your fictitious business name, also known as a dba (doing business as). Registering your dba with the proper authorities puts the public on notice that you are the owner of the business. Corporations are not normally required to file a fictitious business name statement, unless they too are operating under a different name. Also, know that some banks require such a statement before opening a business bank account.