The Right Entity for the Original Company 1

The Right Entity for the Original Company

 >>>> next

One of the first decisions any entrepreneur must make is the choice of entity for a new business. Should it be a corporation, partnership, limited partnership, limited liability company (LLC), or sole proprietorship?

There are also limited liability partnerships, limited liability limited partnerships, and professional corporations. Professionals such as architects and doctors are restricted by state laws to certain types of entities for practicing their professions. They are usually the only ones to use these last three types of entities.

1.   Limited Liability

The major benefit to forming a corporation or a limited liability company (LLC), rather than operating through a partnership or a sole proprietorship, is “limited liability.” That is, if you properly create and maintain a corporation or an LLC to house your business, your personal assets (and your co-owners’ personal assets) will not be subject to claims against the company.

Let us say you start a dog grooming business. You do not use a corporation, but operate as a sole proprietorship, which is not a limited liability entity. A dog attacks a visitor. The visitor sues you. Whether or not you are found liable for the injury, if your business is a sole proprietorship, you may have to exhaust your personal assets (including selling your house), to either pay to defend yourself in the lawsuit or to satisfy a judgment if you default (fail to defend yourself). If the business was operated as a corporation, you may have to exhaust the business’s assets to pay for the suit, and perhaps even close up shop.

Once you put your business out on the Internet, you reach all kinds of people, all over the place. They will be reading your information, perhaps buying things from you, and whatever else your website attempts to entice them to do. The mere fact that you are now exposing your business to the whole world is a good reason to conduct your business through a limited liability entity.

So, assuming you want to do business through a limited liability entity, the next issue is to decide which one. The three most common entities used are the C corporation, the S corporation, and the LLC.

Limited partnerships are also still in use, but they do not limit the personal liability of the general partner. If the general partner is a corporation or an LLC, this will not be a concern. Sole proprietorships and partnerships do not limit the liability of the owners—their assets are subject to the liabilities of the entity.

There is no legal requirement that one must use an attorney to form a company. You can just make a decision and file. That said, there are pros and cons for each type of entity. The answer can be different for each person's circumstances, so it is not easy to provide a formulaic answer.

2.   The Corporation

A corporation is an artificial, legal “person.” That is, a corporation is treated as an independent entity with its own legal identity that allows it to carry on business and also subjects it to legal claims and obligations. The officers and directors of a corporation run its business for the ultimate benefit of its shareholders. In many states, one person may form a corporation and be the sole shareholder and officer.

Each state has its own set of laws governing corporations, including how they must be organized, how they must be governed, how often they must hold shareholders’ meetings, how they can be merged or consolidated, how they can be dissolved, and various other matters. In general, the shareholders elect the directors, and the directors elect the officers. The officers have authority to run the day-to-day operations,but they need directors’ approval to do anything out of the ordinary, such as sign a lease for business space, hire an executive employee, or start a new line of business. For even more major decisions such as sale of all of the assets of the corporation, merger, reorganization, consolidation, or amendment to the certificate of incorporation (in some states, this is called the articles of organization), a shareholders’ vote is required.

An amendment to the certificate of incorporation is required in order to increase the number of authorized shares of stock, add another class or series of stock, change the corporation’s name (although sometimes a shareholders’ vote is not required to do this) and to take various other actions. In most states a majority shareholder vote is required to take most actions which require a shareholder vote, but for certain matters in certain states a two-thirds vote or other vote is required.