Choosing the Legal Form for your Business


Choosing the legal form of your business
One of the most important decisions that organizers of a small business enterprise must make is whether to set up the business as a
• Sole Proprietorship
• Partnership
• Corporation.
A comparison of the advantages and disadvantages of these three major forms of business organization follows:
Start-up Costs
Some basic costs such as rent and the cost of acquiring inventory will vary whether you are a sole proprietorship, a partnership or a corporation. Other costs will also vary especially legal fees involved in setting up your business.
Sole Proprietorship: This is the least costly way to start a business. You can form a sole proprietorship by finding a location and opening the door for business. There are the usual fees for registering your business name and for legal work in changing zoning restrictions and obtaining necessary licenses. Attorney’s fees for starting your business will be less than for the other forms because there is less preparation of documents required.
Partnership: You can form a partnership simply by an oral agreement between two or more persons, but this is not recommended. Legal fees for drawing a partnership agreement are higher than those for a sole proprietorship, but may be lower than for incorporating. However, you would be wise to consult an attorney to have a partnership agreement drawn up, to help resolve future disputes.
A partnership agreement should include the following:
• The type of business
• Amount invested by each partner
• Divisions of profit or loss
• Compensations to each partner
• Provisions for drawing salaries by partners
• Distribution of assets in event of dissolution
• Duration of partnership
• Provisions for dissolving the business
• Provisions for withdrawals or admissions of additional partners
• Procedure for dispute-settlement
• Restrictions on individual authority, especially regarding expenditures
• Settlements in event of death or incapacity of one partner
Corporation: You can incorporate without the help of an attorney, but you would be unwise to do so. You may think a small family corporation does not need an attorney, but an attorney can save the members of a family corporation from hard feelings and family squabbles down the road. Attorney’s fees may run high, if organization problems are complex. The corporate form is usually the most costly to organize.
Control of the Business
Sole Proprietorship You have absolute authority over all business decisions.
Partnership Control of the business is shared with your partners, which may lead to disputes. A partnership agreement could be helpful in solving possible disputes. However, you still are responsible for your partner’s business actions, as well as your own.
Corporation Control depends on stock ownership. If you have majority stock ownership, you are able to make policy decisions. Control is exercised through regular board of directors meetings and annual stockholders’ meetings. Records must be kept in order to document decisions made by the board of directors. Small, closely held corporations can operate more informally, but record keeping cannot be eliminated. Officers of a corporation can be liable to stockholders for improper actions.
Tax Considerations
Sole Proprietorship and Partnership: All net income is taxable to the sole proprietorship or to the partnership according to each partner’s share of ownership. Your tax rate depends on your income bracket. You may be able to deduct from your gross income some personal expenses that are directly related to your business. Some examples are:
• Personal car expenses to the extent used in the business
• A share of expenses if your business is located in your home
Corporation: There are two ways to tax a corporation: (1) as a straight corporation and (2) as a Subchapter S corporation.
As a straight corporation, profits are taxed at corporate rates that are graduated from 22% on the first $25,000 of income to 48% of income over $25,000. Salaries of officers are deductible expenses and therefore reduce corporate profit subject to income tax. However, salaries of officers are subject to individual income tax. If salaries appear too high, the IRS may treat the excess as a dividend. This means double taxation because the same money is taxed as a part of the corporate profit and as income to individuals.
If you are a Subchapter S corporation, you are taxed in the same way as a sole proprietorship or partnership. In order to qualify as a Subchapter S corporation, you must meet the following requirements:
• Have individual shareholders
• Have not more than 10 shareholders
• Have no shareholders who are nonresident aliens
• Have only one class of stock
• Have not more than 80 percent of gross receipts from outside the United States
• Have not more than 20 percent of corporation gross receipts from royalties, rents, dividends, interest, annuities, and gains on sales or exchange of stock or securities.
Ability to Raise Capital
Sole Proprietorship and Partnership: The source of capital is usually limited to personal assets of the proprietor or partner. The ability to get credit depends on personal reputation of the proprietor or partners. Third parties cannot invest in the business without incurring responsibilities for business debts.
Corporation: A corporation can theoretically sell stock to raise capital. Practically speaking, there is no market for stock in small corporations, except through friends or relatives. You may be limited to the personal resources and credit of the owners.
Continuity of the Business
Sole Proprietorship: If you are disabled, the business will falter unless family, friends, or employees are willing and able to substitute for you. Death of a sole proprietor means the end of the business, but your heirs can inherit the assets of the business. Your heirs can start a new business using the same assets and locations, providing your creditors are paid.
Partnership: If one partner is disabled, the other may be able to fill in until the disabled partner recovers. One partner cannot sell his share in a partnership without getting the consent of his partners. Death dissolves a partnership automatically. Heirs of a partner inherit his share of the Partnership assets. Without a partnership agreement, the heirs often have to sue to enforce their legal rights.
Corporation: A corporation is a separate legal entity. Its existence is not affected by death or disability of shareholders. Shares of stock can be sold if one owner wants to leave the business. On the death of a shareholder, his stock goes to his heirs.
Personal Liability of Owners
If you are borrowing from a bank, SBA or other lending institutions, personal guarantees of all principals and their spouses will be required. Certain types of liability can be insured against, such as liability for accidents to customers on your premises. The following is concerned with personal liability for trade debts.
Sole Proprietorship: All personal assets are available to creditors to satisfy claims against you. This does not generally mean creditors can sell your home. If you and your spouse jointly own your home, your spouse is not liable for your business debts, and his or her interest in the house is not divisible. A creditor can obtain a judgment, which is good for 20 years. In that period, your spouse may die, leaving you sole owner. You and your spouse may divorce, or more commonly, you may wish to sell and move elsewhere. If any of the above happens, you would have to come to terms with your creditors.
Partnership: The general rule is that all personal assets are on the line for business debts incurred by you or your partner. This may include your home, in which case the personal liability is the same as for a sole proprietorship unless your spouse is a partner. If you have more money than your partner, you may have to bear the brunt of business debts, even though the partnership agreement says you will split debts fifty-fifty. A partnership agreement does not bind third parties who are not aware of it.
Corporation: If you invest an amount of money in a corporation, you can lose only that amount plus the time and effort you put into the business. Creditors of corporations cannot reach your personal assets for corporation debts.
Choosing the Legal Form for your Business For more information  101 Pet Sitting Business

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About Debbie June Rickman Laughlin

Wrote 101-A: Pet Sitting Business "Work Book To Conquer Success", to help others in the industry, Founder/ CEO of House Calls Pet Sitting and Home Care Services. Established 1981 and still going strong, To relax I do Photography and Painting. View, and Purchase my art at:

Discuss: “Choosing the Legal Form for your Business”

  1. August 16, 2012 at 10:17 pm #

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    Posted by Tobiah


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