Business law is a broad category of laws which refer to local, state, and federal laws which govern the formation and daily operation of all types of business entities. This includes all types of businesses from corporations to sole proprietorships.
Having a basic understanding of the different available types of business structures is essential for an individual to determine the best way to structure their business. In addition, it may be useful if an individual is considering altering their existing business to a new type of structure or if they are considering selling their business to another individual or company.
What is a Business Structure?
A business structure is the way in which a business is organized in terms of direction, leadership, and rights and liabilities. In addition, they way in which a business is structured is one of the most important decisions an individual can make as it will affect the following areas of the business:
- The amount of taxes that the business will be required to pay;
- The amount of personal liability an individual will have related to the business;
- The amount of paperwork required to establish and maintain the business; and
- The advantages and disadvantages that come with each type of business, which should be analyzed carefully to ensure that an individual chooses the correct type of business structure for their needs.
There are several factors an individual should consider when choosing a business structure, including:
- The potential risks and liabilities that inherent to that type of business structure;
- The costs incurred to establish and maintain that type of business structure;
- Potential investments required; and
- How the federal government and state government will tax the business.
There are numerous different types of business structures. Some common business structures include:
- Sole proprietorships;
- Partnerships;
- Limited partnerships;
- Limited liability partnerships; and
- Corporations.
Sole proprietorships are businesses that have only one owner and are not required to be registered with the state. They are easy to set up and maintain.
An owner of a sole proprietorship makes all of the management decisions for the business. All of the liabilities and profits belong solely to the owner of the business.
Although a sole proprietorship is simple, it still requires that the owner ensure that the business remains legitimate in the community in which it operates as well as keeps up to date with any requirements, including:
- Local registration;
- Business licenses; and
- Other required permits.
One major disadvantage of a sole proprietorship is that the owner does not have any protections in the event that they have liabilities or are sued in a court of law. This disadvantage is balanced with the owner having total control over the business.
A partnership, also called a general partnership, does not require any formalities in order to be formed. A general partnership exists where two or more individuals are engaged in a business for profit.
The individuals in the partnership agree to share in the profits as well as the financial losses of the partnership. In addition, each partner is individually liable for the debts of the business in the event that the business itself is unable to pay its debts.
Further, if a trot, contract, or criminal liability lawsuit is brought against one individual partner, it is brought against the other partners as well. In general partnerships, all of the partners are considered agents for the other partners.
Therefore, partners have a fiduciary duty to act in the best interest of the partnership. If one partner breaches their fiduciary duty, the other partners may be able to sue the breaching partner for damages which resulted from that breach of duty.
Another type of partnership is a limited partnership. Limited partnerships require one or more general partners and or or more limited partners.
In limited partnerships, one partner is required to be a general partner. General partners make management decisions for the business as well as assume 100% of the risk for any debts and liabilities of the limited partnership.
In contrast, limited partners do not make management decisions. They are also only liable for the amount of the financial contribution which they originally made to the limited partnership. Even so, all of the partners in the limited partnership, both general and limited, share in the profits of the business.
Limited Liability Partnerships, or LLPs, are partnerships in which one or all of the partners have limited liability for the LLP. An LLP is a distinct type of business structure because it has elements of both a partnership and a corporation. One main characteristic of an LLP is that the partners are not responsible or liable for the misconduct or negligence of the other partners.
Corporations are legal entities which are owned by shareholders within the corporations and are created and regulated by state laws. The corporations themselves, not the shareholders, are legally liable for any actions of the corporations as well as the debts the corporations may incur.
Corporations enjoy most of the rights and responsibilities which individuals possess, such as the ability to:
- Enter into contracts;
- Obtain loans;
- Sue and be sued;
- Hire employees;
- Own assets; and
- Pay taxes.
There are different types of corporations. These include:
- C corporations;
- S corporations;
- Professional corporations; and
- Non-profit corporations.
A C corporation is a traditional corporation. C corporations have business structures which are created as separate and distinct legal entities from their owners. The advantages of C corporations include:
- Limited liability for owners;
- Tax benefits; and
- The ability to attract investors and to raise capital.
S corporations are structured in a way that provides a pass-through entity for tax purposes. Being a pass-through entity means that the income or losses of the corporation pass through to the tax returns of the individual shareholders. However, an S corporation has the same limited liability as a traditional corporation.
Professional corporations are made up of groups of professionals. The list of professionals who are permitted to form professional corporations varies from state to state, so it is important for individuals to ensure that their profession is included. Typical professions that are eligible to form professional corporations include:
- Accountants;
- Engineers;
- Lawyers;
- Physicians; and
- Other healthcare professionals.
Non-profit corporations are formed for the purpose of conducting activities and transactions for purposes other than the financial gain of the shareholders. Although a non-profit corporation is permitted to make a profit, that profit must be used to further the goals of the organization instead of providing income to its shareholders.
Limited Liability Companies, called LLCs, have the limited liability of a corporation but are not held to the same strict management requirements of a corporation. An LLC can only be formed by following the laws of the state in which it is formed.
LLCs combine the pass through taxation structure of partnerships with the limited liability of corporations. LLCs have managers, members, and, in some cases, employees.
The owners or members of LLCs participate in the management of the businesses. However, they are not held personally liable for the debts of the LLCs as they are in general partnerships or sole proprietorships.
Do I Need an Attorney?
It is essential to have the assistance of a corporate attorney for any issues or questions you may have related to your business, whether you are just starting out or your business is already established.
Your attorney will be able to explain in detail each available type of business structure, how your state laws will apply, and which will best suit your needs. Having a business attorney involved in your business is one of the best investments you can make in the success of your business.
