Basic Business Structures

Ouch! I have to pay my now defunct business' debts to the Internal Revenue Service and a creditor out of my personal money. How can this be true? A business owner's failure to choose the proper legal and corporate structure often leads to such a tragic result. How one structures a business affects ownership rights, personal liability and risks, and how the business can operate. Common business structures include corporations, limited liability corporation (LLC), limited liability partnership (LLP), and sole proprietorship.

Corporations

The Encarta Dictionary defines a corporation as "a company recognized by law as a single body with its own powers and liabilities, separate from those of the individual members." To form a corporation, a business owner must file Articles of Incorporation with the Secretary of State. In Ohio, as a minimum the Articles of Incorporation must contain a name that includes either "Company," "Co.," "Corporation," "Corp.," "Incorporated," or "Inc.,"; the corporation's principal office location; number of shares of each stock classification and par value; amount of stated capital; and a statutory agent. Other provisions of the Articles of Incorporation can provide limits, protections, and powers that affect corporation operation. Bylaws govern the internal affairs of corporations. As a legal entity, a corporation can have its own bank accounts, assets, and even secure financing.

• Advantages: Investors have limited liability. Investors' liability is limited to their investment in the corporation. A wall of separation exists between company finances and the owners' personal finances. For instance, corporation representatives can sign for loans on a corporation's behalf, rather than having personally to take out loans for the corporation's benefit.
• Disadvantages: Corporations must comply with a great many regulations that do not apply to other business structures. Costs of incorporating can be high. Founders often lose control to other shareholders. An attorney can help ensure corporate documents protect the corporation and the individuals who operate it.

Limited Liability Corporation (LLC)

Often described as a combination between a corporation and a partnership or sole proprietorship, an LLC provides a flexible business structure. LLCs have the flexibility of a partnership or sole proprietorship and the legal protection of a corporation. Establishment of an LLC requires incorporation. However, incorporation of an LLC is simpler than a traditional corporation. The LLC has become one of the most popular business structures.

• Advantages: LLC Members have protection from personal liability. LLC members may choose the LLC to operate as a flow-through entity for which income and its members report losses direct. Members may get special divisions of income, expenses, deductions and losses, and an individual member's losses are not limited by a member's investment.
• Disadvantages: Nothing in the IRS Code ensures the current flexibility of LLC tax treatment. An attorney should be used to ensure corporate documents protect the corporation and the individuals who operate it.

The Limited Liability Partnership (LLP)

A general partnership is formed simply by two or more people carrying on a business with the goal of earning a profit. Partners have much exposure to liability. Each partner is liable for his actions, his partners' actions, and actions of employees.

The LLP structure has much in common with the general partnership structure. However, in an LLP, each partner is not liable for the actions of other partners. LLPs end existence upon the death of a partner.

• Advantages: Since income passes through to the partners, who are individually responsible for taxes, the LLP has no tax liability. Partners have no liability for the actions of other partners.
• Disadvantages: Ohio recognizes LLPs, but many states do not recognize LLPs. States that do not recognize LLPs may treat Ohio LLPs as general partnerships in their states exposing partners to liability.

Sole Proprietorships

The sole proprietorship is the most common and easiest to form. Compared with other business structures, few regulations apply to it. For tax and legal purposes, the business and owner are viewed as the same. When the owner dies, the business no longer exists.

• Advantages: Sole proprietors own the entire business. They keep maximum control and freedom to operate the business. Starting a sole proprietorship typically only requires getting a business license and a registered business name.
• Disadvantages: The owner of the business has unlimited liability for taxes and any legal issues that arise from operating the business. Judgment holders against the business may enforce judgments against the owner. Sole proprietors often find it difficult to find financing for the business.

Many ways exist legally to set up a small business. Sole proprietorships are the easiest to form but offer the least protection from personal liability. They also offer the most flexibility for operation. On the other hand, corporations provide the most personal liability protection at the expense of flexibility and expense of formation. LLCs provide limited personal liability and more flexibility for operation than a traditional corporation. The Ohio Secretary of State has published a "Guide to Starting a Corporation in Ohio" that contains essential information for anyone considering starting an Ohio corporation.