By Ron Kustek
You may be considering starting your own business, or you may have already started a business and have been operating for a number of years. Either way, what formation your business takes can either help you, or hurt you.
The basic business formations are as a sole proprietorship, a general partnership, a corporation (C-corp) or as a nonprofit (501c3). There are also limited liability companies (LLCs) and S-Corps, all with varying degrees of advantages and disadvantages.
Sole proprietorship offers the advantages of 1-person control, decision-making and responsibility. This one person makes all the decisions on behalf of the company of employees, and also gets to keep all the profits – one of the biggest advantages. Your tax situation is relatively easy as a sole proprietor, as there is much less costs and paperwork for its formation as well as for tax filings.
Some of the disadvantages are that you are solely responsible for all the strategy, day to day managing, and also access to any financing that may be needed for the company to continue operating or growing. Another major disadvantage is that you have unlimited liability — there is no separation between you and your personal assets (home, car, personal bank account etc.,). So, if you and your business are sued as a sole proprietor, then you may risk losing your car, home and all your savings.
A general partnership offers the advantages of shared control, shared decision-making and responsibility. Formed when two or more people combine their investment in the business as well as their skills, long-term as well as day-to-day decisions are shared among the partners, as well as the profits.
This shared management and responsibility can bring together people with varying skill sets in order for the partnership to succeed and grow, vs. expecting a single person/sole proprietor to have all the skills required for maximum possibilities. Some of the disadvantages are that you hopefully get along with each partner, now and in the future, as shared decision-making and management doesn’t always go smoothly.
In California, you need to file your partnership agreement with the Secretary of State’s office, outlining as many “what if” scenarios as possible, from when one partner chooses to sell, or dies, or other major changes in the structure of the business, and this does have some minor costs associated with the filing. Also, there is the risk of liability, because if one of the partners does something illegal, then the entire partnership is responsible and liable for the infraction.
A corporation offers many more advantages than either a sole proprietorship or a general partnership. A corporation can have either a number of officers of the corporation — or — a single person as the only officer of a company formed as the corporation. Corporations big or small often have greater access to capital for financing, as there is a higher level of expertise required in forming a corporation, thus many financial institutions have more faith in the education and business management of the people running the corporation.
You can choose who has which level of decision making, which level of authority, who is responsible for what aspect of the business, which are all part of your Articles of Incorporation, which are required to be filed with the State of California upon incorporating.
Additionally, there are other filings required to be a corporation, as you can also determine the number of shares of stock for the corporation, based on how you choose which officers to have which percentage of ownership in the corporation.
This is a bit more complicated structure and a bit more complicated to form, but the corporation gets taxed as its own entity — unlike a sole proprietorship, as corporations pay a much lower tax rate than sole proprietors or individuals.
The greatest advantage in forming as a corporation is that you have greater protection, as the liability of the corporation stops with the corporation. Unlike being sued as a sole proprietor, if you’re sued as a corporation they can only go after the corporation’s assets, and not any officer’s personal assets. Remember, “corporations are people” under the recent Supreme Court ruling, and thus the liability is with the single entity — the corporation — and not the corporation plus anyone else.
Business matters, and the person who can help you best determine how you should form your business, is your accountant. Your accountant will look at both your personal and/or family filing situation as well as your business, and determine what is best for you in totality, as well as review with you other issues that are best for you now, and for your financial future.
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Ron Kustek is a former senior executive and also small business owner, who is currently a business instructor at Cabrillo College. Contact him at [email protected].
