You’re in business. Congratulations. Small business is the backbone of our economy. But have you thought about what kind of small business structure suits your particular business best?
When they’re just getting started, many people begin with a “sole proprietorship”. An individual owns the business and is maybe the only worker in the business. There aren’t any costs in establishing a sole proprietorship. But there aren’t any protections either.
If your business gets sued, then the liability flows through to you directly. If there is a judgment against your business, it’s a judgment against you. Your house or other assets could be vulnerable.
Supposing you decide to expand into a partnership? Perhaps you offer the possibility of joint ownership to an employee, in return for an infusion of capital. Maybe, with legal assistance, you draw up a formal partnership agreement which stipulates the partners’ respective ownership interests. It doesn’t have to be 50/50: maybe you’ve put in more money, or maybe your established good will is worth something which should be recognized in the partnership agreement. Your formal partnership agreement can also stipulate exactly how much each partner can draw from the net profits of the partnership and what your intentions will be if the partnership should fall apart down the road – that is, how the partnership will be terminated. That can certainly save litigation costs in the future.
But even if you do not have a formal partnership agreement in place, a partnership can be deemed to have arisen by “course of conduct”: that is, possibly by an employee “holding himself out” to a client as having authority to bind the partnership. If it turns out your “partner” is judgment proof – lacking assets to meet the legal claim against the business– then you could bear all of that responsibility yourself. Your lawyer can help you understand when might be the right time to draw up a partnership agreement and how that partnership should optimally be structured: a general partnership, a limited partnership or (for some professional partnerships) a limited liability partnership.
What about incorporation? Incorporation involves costs. There are the initial costs of incorporation and there are also annual accounting costs for tax purposes. An individual can incorporate, and so too can partners incorporate. Shareholders’ respective interests can be related to the proportion of shares each owns. These up front and annual costs of incorporation may not be justified to you until your business is generating a certain level of profit beyond your income needs, which possibly you wish to retain within the corporation for purposes of tax planning.
However, the big benefit of incorporating your business is putting up some protection against potential flow of liability to yourself personally or to your partners if your business is sued. If you’ve incorporated your business, it’s the “corporation” which will be sued. In most cases, someone suing an incorporated business cannot “pierce the corporate veil” behind the corporation to get at the owners or directors of the corporation personally: although directors’ liability insurance is in many instances a further safeguard. Your incorporation documents will also take into consideration the assets of your firm and what you intend should happen upon wind-up of the incorporation in future. And of course if your small corporation needs to borrow money or enter into a business premises lease, you may be required to sign onto a personal guarantee: incurring personal liability once again.
Sole proprietorship, partnership, corporation: what type of business entity best suits your business? Or would your business benefit from some sort of “joint venture” structure, bringing together two or more legal “persons”? These are questions worth discussing with a lawyer who listens to you. You want a lawyer who understands what stage your business is at and who offers sound advice, in collaboration with your accountant providing tax advice and possibly your insurer providing insurance advice, as may be appropriate.
If the default is “sole proprietorship” or possibly “partnership”, our lawyers can explain on a costs/benefit analysis when it may be the right time to formalize your business structure. You want to be clear about the potential legal consequences which may arise if no formal business documentation has been put in place. Anderson Adams is a small business which cares about small business. We can help you make the right decisions for right now and in the future as your business prospers and expands.
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