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SELECTION
OF BUSINESS ENTITY*
There
is much more to starting a new business than picking a
location, buying equipment and hiring employees. Too
often, entrepreneurs focus only upon opening their doors
and ignore one of the most important aspects of the
business start-up process: selecting and forming the
proper legal entity from which to run a business. Giving
attention to such details in the beginning can save you
money and headaches, and even your business, later on.
There
are just as many types of businesses as there are legal
entities from which to run them. Often, the choice of
entity depends upon certain factors concerning the new
business. This article will introduce some of those
factors and the various business entity choices which
logically follow from them.
The
first question a lawyer will usually ask about any
proposed business is: "Who will own it."
Frequently, businesses are owned and operated by an
individual person. These businesses, also called sole
proprietorships, leave the owner personally liable for
all debts and obligations flowing from them. For
example, if a solely-owned business serves the public,
such as a nail salon or restaurant, the owner is
personally exposed to lawsuits from the public for
injuries or other damages claimed against the business.
Likewise, the owner will be personally responsible for
all tax obligations and debts of the business.
An
often asked question is: "Can a single person form
and own a corporation?" The answer is yes, an
individual business owner can form a corporation to own
and operate his or her business. Doing so can provide
the owner with protection against certain liabilities of
the business. There are many different type of
corporations, however, and an entrepreneur should
consult an attorney in choosing the proper one.
Additionally, even when a corporation is formed, if the
owner does not carefully comply with the numerous
Georgia and federal laws and regulations regarding the
formation and continuing operation of that corporation,
the owner will remain personally liable for all debts
and obligations of her business.
If a
business is to be owned by two or more persons, the
owners should form a legal business entity, typically
either some type of corporation or partnership. Again,
the choice of which type of corporation or partnership
is complicated, and depends upon numerous factors. One
such factor is whether the owners will have equal
management and ownership rights in the business. If the
owners do not want centralized control over the
business, but would prefer to have equal say in all
business affairs, some form of partnership may best
serve their needs. Partnerships can allow each partner
to have full control over the daily affairs of the
business. Such an arrangement also means, however, that
the partners will have joint responsibility for all
debts and obligations of the business. It is important
to note, however, that even certain types of
partnerships allow for unequal management and ownership
rights, as well as unequal assessment of tax and other
liabilities among the owners.
If, on
the other hand, owners desire to have centralized
management, basically meaning that control over the
business is delegated to individuals appointed by the
owners (which can be the owners themselves), a type of
corporation may be the better choice for their business.
In most corporations, the owners select directors to run
the business, and the directors in turn select officers
who manage daily affairs for the business. Like
partnerships, corporations allow owners flexibility in
splitting ownership of the business among them. However,
unlike partnerships, the liabilities of a corporation
are assessed against the owners in proportion to their
individual ownership interests in the corporation.
In
addition to management and liability, another important
consideration in choosing between some form of
partnership and corporation is the tax consequences of
such choice to the owners. Generally, a partnership
results in the partners being taxed individually for
their respective shares of the partnership's income.
This "pass-through" tax typically means that
owners are only taxed once at their own individual tax
rates for all earnings of the partnership. On the other
hand, most corporations are taxed separately at a
different rate from the owners' individual tax rates.
This may result in "double-taxation," since
the owner will also be taxed for distributions made to
the owner by the corporation. However, to avoid this
harsh tax consequence, most corporations pay owners a
salary (which is taxed at the owner's individual tax
rate and provides the corporation with a business
expense deduction) and minimize shareholder
distributions which otherwise will also result in tax to
the owner.
A
second question most frequently asked is: "What
type of business is it?"
Often,
the amount of potential liability a business exposes its
owner or owners to will dictate what form the business
will take. Any business which is open to the public and
provides a service gives rise to potential personal
injury and other types of lawsuits. Using the nail salon
example again, a customer might sue you for many things
ranging from injuries sustained by slipping on the store
floor after you mopped it, to pain and suffering from
improper nail treatment. Without the protection of a
properly formed and run corporation, you will be
personally liable for any judgment awarded to that
customer for his claims.
The
above are but a few of the general factors to consider
in choosing the proper legal entity which best suits
your business needs, and should not be relied upon as
legal advice. Distinctly unique problems exist with
every new business, and the prudent entrepreneur should
discuss those problems and needs with an attorney before
embarking on a new business.
© 2004
Jay D. Brownstein, Brownstein Nguyen & Little LLP. All
rights reserved.
*This
article is intended for general information purposes
only. Legal issues affecting individual companies
require separate analyses and solutions. You should
consult an attorney for legal advice specifically
tailored to suit the needs of your firm and business.
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