- Listen carefully to clients’ business formation goals
- Assist clients with the selection and formation of business entities, including corporations, limited liability companies, general and limited partnerships, and non-profit organizations
- Assist with the annual maintenance of the clients’ corporation by preparing annual director and shareholder minutes and filing Statements of Incorporation with the Secretary of State
- Structure tax-free mergers and reorganizations
- Draft buy-sell and shareholder agreements
- Advise and plan for business exit strategies
- Secure compliance with securities exemptions
- Wind down and dissolve business entities
There are many factors to consider in choosing a business entity. Circumstances may change as the business grows and/or alters course. A business may operate as a sole proprietorship or partnership for a period before converting into a new business structure like an LLC or corporation. The four most common factors to be considered when choosing and organizing a new business entity are:
- Costs and procedures for formation
- Protection from personal liability for company obligations
- Operation and management
- Tax considerations
Follow these steps to choose the right business organization.
Step 1: Understand the general design of business organizations and identify which one(s) apply to your circumstances
- Sole Proprietorship: the individual engages in business personally rather than through a separate entity.
- Partnership: An association of two or more persons to carry on as co-owners of a business for profit.
- Limited Partnership: Partnership with one or more limited partners. Must have at least one general (personally liable) partner.
- Corporation: A separate legal entity whose owners are “shareholders.”
- Limited Liability Company (LLC): A relatively new unincorporated entity whose owners are “members.”
Step 2: Consider the potential personal liability exposure of each type of entity:
- Sole Proprietorship: Owner is personally liable for all obligations of the business.
- Partnership: Partners are personally liable for all partnership obligations.
- Limited Partnership: Limited partners have limited liability; general partner(s) are generally liable.
- Corporation: Owners are not personally liable, subject to exceptions:
- debts personally guaranteed
- improper distributions (Corp code 506(a) and 2009(a))
- Alter ego/piercing the corporate veil
- Liability for tortuous conduct as director/officer/employee
- LLC: Members have limited liability and are subject to exceptions similar to corporations.
Step 3: Become familiar with the managerial control of each type of entity.
- Sole Proprietorship: Owner has complete control.
- Partnership: Each partner is an agent with authority to enter into transactions on behalf of the partnership.
- Limited Partnership: Only the general partner(s) may participate in operating the company.
- Corporation: Directors are elected by shareholders. Directors and officers operate the business.
- LLC: Can be member-managed or manager managed and may elect officers.
Step 4: Consider the taxation of each type of entity.
- Sole Proprietorship: Not separately taxed. Income/expenses reported on schedule C to 1040 personal return. Must pay self-employment tax.
- Partnership: Not taxed as a separate entity. Profits and losses are passed on to partners. State and federal information returns and schedule K-1’s are filed. Must pay self-employment tax.
- Limited Partnership: Generally same as for general partnerships. Also must pay annual minimum in California. Franchise Tax =$800
- C Corporation: Profits are taxed at entity level; potential double taxation. Minimum franchise tax. More tax deductions for employee benefits.
- S Corporation: Profits/losses are “passed through” to shareholders, like a sole proprietorship/partnership. No self-employment tax; salaries and draws. Minimum Franchise Tax of greater of $800 or 1.5% of net income.
- LLC: Can elect to be treated as sole proprietorship, partnership, corporation, or S corp. Minimum Franchise tax of greater of $800 or higher, based on the percent of gross income.
Step 5: Consider the start up and continuing costs associated with each type of entity.
- Sole Proprietorship: No filings, fees, or minimum franchise taxes. May need to record a fictitious business name statement.
- Partnership: No filings, fees or minimum franchise taxes required, though partnership statement is recommended. Written agreement is recommended.
- Limited Partnership: A certificate of limited partnership must be filed, costing a filing fee of $70.
- Corporation: Must file articles of incorporation, prepare bylaws, originate minutes, stock certificates, statement of information, securities registration and exemption, obtain an Employee ID Number and file with the Employment Development Department. Must prepare annual minutes and statement of information.
- Limited Liability Company (LLC): Must file Articles of Organization and Statement of Information. Operating Agreement is recommended but not filed. Depending on tax election, may need to obtain EIN, issue certificates of interest, and file securities exemption.
Other factors to consider in selecting an entity
- Increasing capital is a MUST
- Coordinate with exit strategy/transferability of interests
- Dictated by circumstances
- Recognition as valid business/tradition/standard in the industry
- Flexibility among the owners
- Interstate activity – Is registration required in other states?
- Complexity of business
- Future conversions, mergers and acquisitions
- Other structures/variations may be more appropriate:
- Limited Liability Partnership
- Joint Venture (general partnership)
- Strategic alliances with other entities through agreements
- Nonprofit entities