There are various ways to form your business. Such as: Sole proprietor, Incorporated, Corporation, Partnership, Co-operative, Limited company, Limited Liability Company (some states).

Unlimited liability

Advantages

Even though the form of your accounts is not described explicitly by law it is advisable to keep proper accounts and to produce a profit and loss  account as well as a balance sheet at the end of the year. If running your business does not necessitate bank line of credit (overdraft), hiring personnel, large suppliers’ credits you could consider to setup as a sole proprietor. If your expected net profit is under $50,000 you could consider operating as a sole proprietor. Since the corporation tax will be too high compared to the actual result.

Disadvantages

You are liable for all the company assets as well as your private possessions. All assets (company and personal) can be seized to pay the company’s debts. In such case you can be declared bankrupt.

Setup

– inform your tax inspector
– inform the local Dept. of Health and Social Security
– inform if you need to register for sales tax

Partnership – unlimited liability

The partnership is to be compared with the sole proprietor. However, each partner is jointly liable with the other partners for all the debts that each partner creates. Your personal assets could be seized even for your partner’s debts. From many experiences our advice is to never form a partnership for this reason. No one, not even your best friend, is to be trusted where business and large sums of money is concerned. The limited company or corporation is the better choice. If you decide to use one of these company forms however please do consult your attorney first and let him draw up the partner agreement.

Co-operative

This company form is not regular for small business. Further information is easy to find and is therefore not provided here.

Limited liability

Advantages

For any trading purposes these are the most interesting company forms. The shareholders and officers of the company (directors, secretary) are only liable for the amount paid for their shares. The personal assets can only be seized because of fraudulent behavior. This depends on specific laws of your country or the state of incorporation. Capital is raised by issuing shares. It is possible to sell some or all of the shares. Unlimited contributions can be made to company pension. Continuation of the company does not depend upon the directors only.

Disadvantages

Your accounts have to be according to law and have to be filed each year at the proper authorities. Any person can inspect them. The accounts must also be audited by a registered accountant. You will have to pay social security contributions as director (employee) of your company and your company will pay contributions as employer. Unfortunately, these rates are much higher than those for a sole proprietor. You will receive full benefits however.

The taxes you pay are normal income tax on your salary and drawn dividends (up to 40%) not on your entire profit. The company however pays corporation tax on its profits. The sole proprietor however pays income tax on the entire net profit of the company. As a sole proprietor you do not receive a salary so your salary is the net profit, and this is taxed as income. When net profit is higher than $50,000 the limited company will save you money.

 

Type of incorporation Formalities Personal liability Fringe
benefits
Raising
capital
Duration of
existence
Sole proprietor Little Yes Few Difficult Cancellation or Death of Owner
General Partnership Little Yes None Difficult Dissolution or Death/Bankruptcy
of a partner
Joint venture Little Yes None Complex Dissolution or Death/Bankruptcy
of a partner
Limited Partnership Some Yes for General Partners Some Complex Dissolution or Death/Bankruptcy
of a partner
Limited Liability Partnership Some No Many Easy Dissolution or Death/Bankruptcy
of a partner
Limited Liability Company (LLC) Many No Many Easy Dissolution or Death/Bankruptcy
of a partner, or Perpetual
Corporation (Corp.) Many No Many Easy Perpetual
S Corporation (Corp.) Many No Many Easy Perpetual
Non Profit Corporation Many No Maximum Easy Perpetual

 

Corporate entities have to deal with several formalities such as annual meetings, corporate minutes of the meetings, officers must be appointed, shares have to be issued or transferred, and so forth. If corporate formalities are not handled properly, the shareholders can be held personally liable for corporate debts if so ruled by a court of the IRS. The corporate entity offers considerable fringe benefits (health, retirement plans, etc.) which can be deducted from the taxable income.

Structure

Generally the structure of a corporate entity is as follows:

1) Shareholders
The shareholders own the corporation (equity is divided by the issuance of shares), elect/remove directors, have the power of attorney by vote, have no say in daily activities of the company.

2) Directors
Directors are appointed by the shareholders (during the annual or other meeting), report to the shareholders, are responsible for company policy and strategies, serve for a predetermined time period (usually 1 year), appoint/remove officers, have a say in daily activities but are not directly involved as such.

3) Officers
Officers are appointed by the directors, report to the directors, are responsible for the appointment/removal/supervising of management.

4) Management
The management team supervises the daily activities, reports to the officers.

5) Staff
The staff does the actual work at hand, implements planned strategies, realizes goals, and reports to management.

Setup

The cost of incorporation varies between $100 and $2500. This depends upon the specific necessities you or your business requires. You need at least two persons to form most limited company forms: one director and one secretary. This depends from state to state however. More persons are possible also. If you don’t know anyone to appoint as secretary, this can be arranged by means of appointing nominees for a small amount payable each year. You may have unlimited shareholders.

The limited liability outweighs any other consideration between the choice of conducting your business as a sole proprietor or a limited company. For more information regarding these matters consult with your PlanMagic consultant, accountant, your attorney or incorporating companies. The latter usually provide all services needed.

Excerpt from Business Plan guide of all PlanMagic programs.
Copyright © 1997 PlanMagic Corporation.