Understanding Business Structures

Sole proprietorship is suitable when just one person will own the business and will have final responsibility for its management and development. It is possible to employ other people if you are a sole proprietor, but ultimately the business is the individual, and there is no separate legal status.

Generally, sole proprietors do not have to file any special forms or pay any fees to start the business, although there will be local and state regulations that apply. There is less paperwork to deal with regarding regulation and taxation than for a limited liability company or corporation. As the sole proprietor, you are entitled to all the profits made by the business.

A partnership is a good vehicle when your business will involve two or more people owning a business together. Like a sole proprietorship, a partnership has no separate legal identity and does not generally need to be formally registered with a government office, although there should be a written agreement among the partners.

The structure of a partnership can be flexible, according to the partnership agreement. There is less paperwork to deal with regarding regulation and taxation than for a limited liability company or corporation. Management responsibilities, risks, and losses are shared among the partners. More people involved means that more capital can be raised among them and more varied skills are brought into play. Partnerships cannot be taken over by other businesses.

There are two other kinds of partnership:

• A limited partnership has at least one partner who is a general partner (that is, he or she has management rights and unlimited liability) and at least one limited partner. A limited partner, who may be an individual or a company, contributes a fixed amount (as capital or property) to the partnership, but is liable only for partnership debts or liabilities up to the amount contributed. Also, a limited partner may not be personally involved in the management of a company.
• A limited liability partnership (LLP) has the flexibility and tax status of a partnership, but the benefits of limited liability. Business profits or losses are reported on the owners' personal tax returns; the LLP itself does not pay taxes. The liability of all of the partners is limited to their capital contribution to the LLP, so personal assets cannot be seized to settle debts. LLPs are required to register with the state.

A limited liability company (LLC) consists of stockholder/members whose percent of ownership is based on their capital contribution. LLCs are formed when the business requires outside funding for its operations. Managing member(s) hold management responsibility and unlimited liability. Member liability is limited to the percent ownership. The main advantage of the LLC structure is that its members have limited liability for the debts of the business up to the value of their shareholding. They are not personally liable for company debts. Filing procedures to create an LLC can be complicated and vary by state. You will likely want the assistance of an attorney to create an LLC.

A franchise is a license that has been granted by one business (the franchiser) to another (the franchisee), allowing the franchisee to use the trademark and name of the franchiser, as well as its methods for marketing, managing, administration, and so on, within the business.

There are several advantages to franchising. The franchisee, by investing in a proven business format, can become the owner of a business with a well-known brand name, while at the same time overcoming some of the difficulties associated with a new business. The franchiser will provide help in finding and refurbishing premises, obtaining planning approvals, purchasing inventory and equipment, training staff, marketing, and advertising. The franchisee is therefore able to concentrate on the day-to-day running of the business. The franchiser will be able to provide specialist managerial advice and guidance to help overcome any problems that a small business is likely to encounter, and the franchisee will benefit from the economies of scale of operating as part of a large organization.

As a sole proprietor, you can begin operating your business without filing any sort of incorporation papers. However, be sure to check with city, county, and state authorities on required business licenses and tax requirements. If you have a storefront, you may need approvals from the city, and you should have property and liability insurance in place. If you operate from home and you will have clients visiting your home/office, find out if you are subject to parking regulations or other requirements.

Like a sole proprietorship, when starting a partnership you can simply start operating your business without filing or registering with any authorities. You are not required to have a partnership agreement in writing, but it's wise to have such an agreement written with an attorney's assistance. If you are establishing a limited partnership or LLP, however, contact your state office of corporations, Secretary of State, or state LLC/LLP office to ensure that you have completed the appropriate paperwork. As with a sole proprietorship, you also need to look into your tax obligations, and there may be regulations that apply to your business premises.

A LLC must be registered with the state before opening for business. The state office of corporations, Secretary of State's office, or LLC/LLP office can give you the required papers and instructions. It's best to have an attorney help you draw up and submit these documents. A LLC must have at least one managing member and corporate officers.

Before you make a decision on a franchise, talk to existing franchisees to find out more about their experiences and whether they would recommend franchising with the company you're considering. If you decide to go ahead, and your application is accepted, you will probably find that an interview with the franchiser is required. The interview gives you and the franchiser the opportunity to evaluate one another. Provided both parties wish to continue, there will be a second interview to begin formalizing the agreement. You may want to consult an attorney with expertise in franchising as you go through the process.

A sole proprietor has unlimited liability for the debts of the business, such as bank loans and amounts owing to creditors, so if your business fails, your personal savings and assets could be at risk. In a general partnership, there is unlimited liability, and each partner is personally responsible for the debts of the partnership. As a partner, therefore, your personal assets may be seized to pay off debts. Limited liability companies and corporations must comply with a wide range of complex and detailed regulation that is not applicable to sole proprietorships and partnerships, which can add to the administrative and financial burden.

Sole proprietors will often decide to establish themselves as a corporation to protect their personal assets behind the "corporate veil." In fact, the corporate veil provides little or no protection to sole proprietors even if they have established their company as a legal corporation. Before changing from sole proprietorship to corporate standing, speak with your attorney to determine whether you and your business will be given the protection you seek, or if you are just adding unnecessary expenses and paperwork to your operation.

Franchisers exert a fairly high degree of control over the franchise operation, so although the franchisee is legally independent, he or she will never be completely independent of the franchiser.

Franchises can be expensive investments. After the initial fee, there will be ongoing fees for the continuing support provided by the franchiser. Under the franchise agreement, the franchisee may be obliged to buy supplies and equipment from the franchiser, which they may have been able to purchase cheaper elsewhere.

Cooke, Robert A. Incorporate Your Business: When To Do It And How. Wiley, 2004.

Sugars, Bradley J. and Brad Sugars. Successful Franchising. McGraw-Hill, 2005.

Intuit's mycorporation.com: www.mycorporation.com/incorporate.htm

The Knowledge Exchange: www.myworktools.com/dept/legal

U.S. Small Business Administration: www.sba.gov