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Kawalski, Fletcher & Kirkpatrick, P.C. has put together a list of common asked questions and scenario’s that many current business owners and potential businesses owners are left faced with. If you don’t find the answers to your questions please contact our office and speak to a qualified professional today
Q: What do I need to know if I am going into business for myself? A: You need some business savvy in order to go into business for yourself. Assuming you have a good idea on how to make money, you should develop a detailed business plan before you do anything else. Going through this process will give you a much better idea of what you need to know about your business before you begin operations. Things to cover would include the following:
Beyond all these issues, it is also extremely important for all business owners to know that they can’t know everything. By definition, business is always a risky venture. The best way to quantify the risk is, when appropriate, to rely on other people for advice and consultation. Every business, for example, should have a working relationship with a lawyer, an accountant, an insurance agent and a banker.
Q: What form or business entity should I use? A: Although maybe not the best alternative in the long run, the simplest and cheapest way to start up a business is as a sole proprietorship. A sole proprietorship means you are doing business in your individual capacity and not through any type of business entity. You may operate the business in your own name (for example, John Doe’s Painting), or you may operate under a fictitious name (for example, John Doe, doing business as, or “dba” Acme Painting). Before legally doing business under a fictitious name, you are required to file a fictitious business name statement in the county or township where your business is located. The time tested legal entity to use when forming a business enterprise is the corporation. A corporation is a legal entity that the law treats as a “person” in the sense that the organization has its own corporate identity and existence. As a separate legal entity, a corporation serves as a shield between the owners and third parties doing business with the organization. So long as corporate formalities are observed, the corporate shield makes it difficult for third parties to “pierce the corporate veil” to go after the owners. Instead, creditors and other third parties can be limited to going after the assets of the corporation. A corporation also has its’ own name and identity separate from the owners. It pays taxes and has the ability to contract. It can own property. A corporation can sue and be sued. In some instances, a corporation can be charged with and convicted of crimes. Another alternative is a partnership. A partnership is an arrangement involving two or more people undertaking a business venture as co-owners, with the intent to make a profit. The simplest type of partnership entity is known as a general partnership. Forming a general partnership is the easiest way to go into business with another person. But the simplicity of a partnership can be a problem, so careful planning is important. One of the principal drawbacks of a general partnership is that a general partner can be held responsible for all debts and liabilities of the partnership. Thus, a general partner with only a one percent interest in a business could still be held liable for 100% of the debts and liabilities of the partnership. From a tax standpoint, it’s sometimes better to invest in a partnership rather than incorporating. In order to address the issue of potentially unlimited personal liability, most states also recognize another type of business entity that is called a limited partnership. A limited partnership must have at least one general partner, but all of the other investors can be limited partners whose potential liability exposure can usually be limited to the extent of that partner’s investment. So, for example, if a limited partner invests $10,000 in a business venture organized as a limited partnership, his or her potential liability would be limited to the $10,000 invested rather than the rest of the limited partner’s personal assets. One of the resulting tradeoffs, though, is that an investor must take a passive role in the operation of the business in order to maintain the status of a limited partner. In many ways, a limited partner is comparable to a shareholder in a corporation. Another business entity is the limited liability company. This type of business entity is perhaps best described as a hybrid of a corporation and a general partnership. It’s treated as a corporation for limited liability purposes but as a general partnership for tax purposes. The owners are called “members.” Unlike a shareholder or a limited partner, they don’t have to take a passive role in the business Yet another alternative for a business entity that is sometimes overlooked is a non-profit corporation. Just because a business is non-profit doesn’t mean that it can’t make money. If you think your business idea might be able to operate as a non-profit entity, this is something you would want to discuss.
Q: What are the pros and cons of a sole proprietorship?
A: As
the simplest way to do business, a sole proprietorship is operating a
business in his or her individual capacity rather than through a formal
business entity. Sometimes, a person will run a business as a sole
proprietorship in his or her own name. However, it’s a common practice to
operate under a fictitious name (which is sometimes called a “dba”).
It’s important to understand, though, that a sole proprietorship doing
business under a fictitious name is still just a sole proprietorship.
The biggest benefit to operating as a sole proprietorship is its
simplicity.
You’re your own boss and don’t have to worry about many of the rules and
regulation that apply to corporations and other types of business entities.
You don’t have to worry about filing separate tax returns. In theory, you
don’t even need to keep separate books and records for your business.
However, the simplicity of a sole proprietorship can also be a business
owner’s worst enemy. Why? Because a sole proprietorship
doesn’t give any protection
against the inherent risks and potential liability exposure of running a
business. Creditors are free to go after not only the assets of the business
but also all of your personal assets, such as bank and savings accounts,
land holdings, investments, heirlooms and household furnishings. So if you
operate as a sole proprietor, you’ll want to try to protect your assets
through insurance, homesteading a residence, retirement accounts and perhaps
eventually bankruptcy.
Many sole proprietors operate their businesses with a false sense of
security that insurance provides them with adequate protection against the
perils of personal liability exposure. To the contrary, there are many risks
that are typically not covered by insurance, such as damages for breach of
contract and claims arising out of an employment relationship (like sexual
harassment or wrongful termination).
Q: What are the pros and cons of a corporation? A: A corporation can serve as an excellent investment vehicle. At the same time, though, there are complex bodies of securities law at both state and federal levels that govern the offering and issuance of shares of stock in corporations. Extreme care must be taken before taking on investors. This should never be done without the advice of an attorney.It’s not always an easy process to form and maintain a corporation, as there are many formalities that must be followed. There are also costs in forming and maintaining a corporation that can be avoided if you choose to operate as a different type of business entity. For example, most states charge a “franchise” tax every year for the benefit of operating and maintaining a corporation in the state, regardless of whether the corporation has taxable income. And state laws generally require that a corporation maintain an organizational structure that includes directors, officers and shareholders. The biggest benefit of incorporating is that it provides the owners (the stockholders) with a shield against potential liability exposure. The protection isn’t absolute, but it may be the best protection against personal liability exposure you can get in today’s business world. And a business owner can take advantage of certain tax laws by operating through a corporation. It may also be possible to provide better employee benefits through a corporation. In addition, it may be possible to deduct certain business expenses when operating through a corporation that might not be as easy to justify or to validate if operating as one of the other types of business entities.
Q: What is an "S" Corporation?A: Corporations are generally subject to federal taxation under Subchapter C of the Internal Revenue Code (and this is where the term “C Corp” comes from). However, in certain instances, a corporation can make an election to be treated under Subchapter S of the Internal Revenue Code. Under Subchapter S, a corporation is generally treated as a partnership for tax purposes. What this means is that income and expenses of the corporation pass straight through to the shareholders, which helps to minimize concerns about double taxation. In consideration of such special treatment, however, the shareholders of an S corporation must generally be individuals, and there can’t be more than 75 in a corporation. There are a number of other tricky rules, including when you can decide to form an S corporation.
Q: What are the pros and cons of a partnership? A: A partnership is an arrangement involving two or more people undertaking a business venture as co-owners, with the intent to make a profit. The simplest type of partnership entity is known as a “general” partnership. While it is almost always preferable to put things in writing, the law doesn’t require that there be a written agreement in order to find that there is a legally binding partnership. Indeed, many people find themselves on the wrong end of a legal dispute because they went into a partnership without clearly defining their business relationship. Partnerships, like marriages, are easy to get into but hard to get out of. Partnerships are perhaps the easiest and simplest way to go into business with another person. But the simplicity of a partnership can be its downfall, so careful planning is important. Partners should have a clear understanding as to why they’re entering into a partnership instead of some other business entity. One particular benefit to a partnership is that it’s not a tax-paying entity. While a partnership must file its own tax returns, the profits and losses from the partnership are passed through to the partners. At the same time, however, the tax and accounting rules that deal with partnerships can be exceedingly complicated. One of the principal drawbacks of a partnership is that it doesn’t protect against potential liability exposure any more than a sole proprietorship. A general partner, for example, can be held 100% responsible for the debts and liabilities of the partnership. This is usually true with a general partnership even though a given partner may have only a minority interest therein. So a general partner with only a one percent interest in a business could still be held liable for 100 percent of the debts and liabilities of that partnership.
Q: Is a limited partnership any different? A: From a tax standpoint, partnerships serve as great investment vehicles. However, investors are oftentimes very leery of investing in a general partnership, as every general partner can be held responsible for 100 percent of the debts and liabilities of the partnership. To address the issue, most states recognize another entity that is called a limited partnership. Generally, a limited partner’s potential exposure is designed to be limited to the extent of that partner’s investment. For example, if a partner invests $10,000 in a business venture organized as a limited partnership, his or her potential liability would be limited to that $10,000 investment rather than allowing creditors to go after the rest of the limited partner’s personal assets. The tradeoff is that limited partners must take a passive role in the operation of the business in order to maintain such a status. In many regards, a limited partner would be comparable to a shareholder in a corporation.
Q: So what is a limited liability company and how is it different from a limited partnership?
A: The best way to describe a limited liability company (“LLC”) is as a hybrid between a corporation and a partnership. When properly organized and capitalized, an LLC has the limited liability benefits of a corporation while at the same time having the tax benefits of a partnership. At the same time, an LLC goes a big step beyond a limited partnership by allowing the owners (who are called “members”) be actively involved in the management and control of the entity (as opposed to limited partners in a limited partnership, who must remain passive investors). The LLC is a creature of statute that, in relative terms, has only come into existence in recent years. Thus, the business world is not entirely familiar with the LLC mode of operation (as evident by the fact that even sophisticated investors will refer inaccurately to an LLC as a “limited liability corporation”). An LLC isn’t a corporation and doesn’t have shareholders, nor does it have to have directors or officers. Instead, the owners are called “members” and one or more “managers” make the day-to-day decisions of the business. You file “Articles of Organization” when forming an LLC. An “operating agreement” governs the affairs of the organization (rather than articles of incorporation and bylaws, as with a corporation).
Q: What are some of the most common mistakes that people make when they go into business for themselves? A: The enthusiasm of going into business for yourself must be tempered with being realistic about the risks involved. Statistics show, for example, that most small businesses do not succeed in the long run. Some of the reasons for failure include:
Q: What are some of the major risks in running a business?A: There is no such thing as a business venture without risk. The risks involved can come in many forms, all of which translate into the possibility that you could end up going out of business and lose all of your investment (and possibly much more). Businesses are always going to be subject to market risks from competition and the economy in general. From a legal perspective, though, the problems that most often seem to bring down a business would include:
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