Business formation benefits and risks: LLC most flexible, corporation most protective.
A sole proprietorship is the easiest business to form because no official action is required. When you start doing landscaping for hire, or selling cupcakes to local coffee shops, or any other type of enterprise, a sole proprietorship has been formed.
In a sole proprietorship, you and your company are one. The company's profit or loss is the owner's profit or loss because there is no legal separation between the business and the owner. That means that everything you own could be used to pay the debts of the business, and vice versa.
Another common business formation is a partnership. Forming a partnership is as easy as two or more people agreeing to go into business together. Partnerships are attractive because each person can bring their skills to the business. Like a sole proprietorship, no official paperwork is required to form a partnership. However, a partnership can put your personal assets at a greatest risk, even if you have a written agreement limiting the responsibilities of each partner. Any such partnership agreement is only between the partners and does not affect who can sue you and why they can sue you. For example, you may agree in writing that no material purchase can be made without approval from all the partners; however, if Partner A goes out and buys five new trucks in the partnership's name, the partnership and the partners are obligated to pay for the unauthorized trucks. While Partners B and C could sue Partner A under their partnership agreement, if Partner A is broke, or bankrupt, the other two partners are most likely going to pay for the vehicles. In a partnership, you are at risk for practically anything your partner does.
Forming a corporation or an LLC are the best methods to protect your personal assets from business liabilities. The corporation is a type of business formation that has been in existence many years. The LLC is a more recently developed business type, and is the most flexible.
A corporation is treated as an individual, separate and distinct from its shareholders. This protects the shareholders from the company's debts. Think of it this way: if you had one share of GM stock, none of GM's creditors could sue you and try to take your house for GM's debts. The corporation is distinct and separate from you. Therefore, the corporation's debts are not the shareholder's debts.
However, there are certain formal acts required to maintain the corporate status as a separate individual. For example, each year the shareholders meet to elect a board of directors. The directors then appoint officers to run the corporation. The corporation has its own bank accounts and owns its own property. Failing to maintain these requirements could destroy the separation between the shareholders and the corporation, exposing the shareholder's personal property.
Because of the additional requirements and the possible risk associated with failing to comply with all the requirements of a corporation, many businesses are electing to be an LLC, which brings together the best parts of a partnership and a corporation.
An LLC is comprised of members, not shareholders; therefore annual shareholder meetings are not required. Formal documents are needed to establish the LLC, similar to a corporation. Members can run the business like a partnership. The members can select how they want the entity to be taxed: as a corporation, partnership, or sole proprietorship. An LLC protects each member's personal assets from the LLC's debts and liabilities. However, a member can be liable in a number of ways, including if the member personally injures someone, personally guarantees a debt, or commits fraud or some illegal act.
With the great flexibility afforded by an LLC, it is becoming one of the most popular types of business formation used.
The July Legal Speak is Jeff Waller's last column for Alaska Business Monthly. He is now with the Attorney General's Office for the State of Alaska. We wish him well.
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|Title Annotation:||Legal Speak|
|Comment:||Business formation benefits and risks: LLC most flexible, corporation most protective.(Legal Speak)|
|Publication:||Alaska Business Monthly|
|Date:||Jul 1, 2012|
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