Businesses choose different management forms for different reasons. These reasons include liability and tax benefits. The different management forms a business may take include becoming a corporation, LLC (limited liability company), sole proprietorship, partnership, or limited partnership. It’s important to evaluate the advantages and disadvantages of the business management form specific to the business you plan to engage in.
Questions to consider when deciding how to structure your business:
- What are the potential risks and liabilities inherent to my business?
- What type of costs am I able to incur to establish and maintain the business structure?
- What are my potential investments?
- In what manner will state and federal government tax the business?
There are five basic management structures:
1. Sole Proprietorships – A sole proprietorship has only one owner. A sole proprietorship is not registered with the state as a corporation or a limited liability company. They are easy to set up and maintain.
The owner makes all the management decisions for the business. All profits and liabilities of the business belong to the sole proprietor. Thus, if the business assets cannot pay the bills, the owner of the sole proprietorship will be held personally liable to the creditors. Additionally, an important element to consider is that the sole proprietorship is not a legal entity - it does not exist apart from its owner. Therefore, for liability reasons, someone may not sue your sole proprietorship but sue you personally.
Although a sole proprietorship is simple in theory, it is important that the owner complies with local registration, business license, or permit laws to ensure your business stays legitimate in the community where you work.
2. General Partnerships – A general partnership does not require any formalities to be deemed a general partnership. A general partnership consists of two or more individuals whom agree to own the business together and make management decisions for the business. The partners share the profits and financial losses of the partnership.
One of the most important aspects of a general partership is that each partner is individually liable for the business debts if the business cannot pay for its bills. Additionally, a partner in a general partnership may bring contract, tort and criminal liability on to the other partner because the partners are considered agents of the other. However, partners have a fiduciary duty to act in the best interest of the partnership. In the event partner breaches their fiduciary duty to the partnership, the other partner(s) can sue the other partner for damages resulting from the breach.
3. Limited Partnerships – In a limited partnership, there are one or more general partners and one or more limited partners. In a limited partnership, one partner is required to be the general partner. The general partner makes the management decisions of the business, while the limited partners do not. However, the general partner also assumes 100% of the risk for liabilities and debts of the limited partnership. By contrast, the limited partners only risk the financial contributions they make to the limited partnership. Generally, all the partners in the limited partnership share the profits of the business.
4. Corporations – A corporation is a legal entity owned by shareholders. The corporation itself, not the shareholders, are held legally liable for the actions and debts the corporation incurs. Other parties that make up a corporation include officers, directors, and employees. A corporation can buy and sell property, enter into contracts, and be sued in its own name. Formation of a corporation requires strict adherence to the specific guidelines required by state statutes. The shareholders of a corporation are generally not responsible for the debts of the corporation. There are four different types of corporations including C Corporations, S Corporations, Professional and Non-Profit Corporations.
- C Corporations: A traditional corporation is referred to as a C Corporation. A C Corporation has a business structure that is created as a separate, distinct legal entity from its owners. Advantages of a C corporation aside from the limited liability for owners include: tax benefits and the ability to raise capital and attract investors. However, they may be subject to double taxation.
- S Corporation: A S Corporation is a corporation structured in a manner as to provide a pass-through entity for tax purposes. Pass through refers to manner in which the corporation’s income or losses "pass through" to the individual shareholders tax returns. However the S corporation still maintains the same limited liability of traditional corporations.
- Professional Corporation: A professional corporation is a corporation that certain groups of professionals can form. These types of professionals include accountants, engineers, lawyers, physicians, and other health care professionals. However, the list of professionals that can form professional corporations vary from state to state.
- Non-Profit Corporation: A non-profit corporation is formed in order to conduct activities and transactions for purposes other than shareholder financial gain. While a nonprofit is permitted to make a profit, the profit must be used to forward the goals of the organization, rather than to provide income for the shareholders.
5. Limited Liability Companies – A limited liability company (LLC) shares the limited liability of a corporation, but is not held to the same strict management requirements of a corporation. Similarities to a corporation include that one can only create an LLC by following state laws. An LLC is generally defined as a business entity somewhere between a corporation and a partnership that consists of one or more persons.
An LLC combines the pass through taxation of a partnership with the limited liability of a corporation. A LLC has managers, members, and sometimes employees. The owners (or members) of the LLC participate in the management of the business. Members, managers and employees are not held personally liable for the debts of the business.
Business organization laws vary from state to state. The type of business you are trying to form also affects what type of business organization you are permitted to form. A business attorney will help you determine what type of business structure is best for your organization.