Business Development:

Gestation Stage

Choosing a Legal Structure of Your Business

The type of legal format you chose depends on the following factors:

There are four main ways to organize your business: the sole proprietorship, the partnership, the corporation, sub charter S corporation, and the limited liability company. The legal structure you choose will determine how much paper work you will have to do, how much personal liability you will incur, how you will be able to raise money, and how your business will be taxed. Keep in mind that your initial choice of a business form doesn't have to be permanent.

The sole proprietorship is best suited for a single owner business where taxes or product liability are not concerned. It is the most common form of a start-up business. Many who are just starting a business choose this form until it becomes practical to enter into a partnership or to incorporate.

A partnership is best suited for a business with two or more owners where taxes and product liability are not or much concern. The entity is inseparable from the owners but can have property and debt in its name. There are different types of partnerships dependent on how active a role partners play in the business. General partners share equally in the responsibility for managing and financing the business. They also share equally in the liability. Limited partners risk only their investment in the business and are not subject to the same liabilities as a general partner as long as they do not participate in the management and control of the enterprise.

Care should be taken when cho0sing a partner. This is a close working relationship and you must look carefully at the work style, character, personality, financial situation, skill, and expertise of your potential partner.

The partnership agreement should outline the financial, managerial, and material contributions into the business and delineate the roles of the partners in the business relationship. It will serve as the guideline for your working relationship with your partner. The following are some subjects often covered in a partnership agreement:

• The purpose of the partnership business

• The terms of the partnership

• The financial contributions made by each partner for start-up and during the lifetime of the business

• The distribution of profits and losses

• The withdrawal of contributed assets or capital by a partner

• The management powers and work responsibilities or each partner

• The provisions for admitting new partners

• The provisions for expelling a partner

• The provisions for continuing the business in the event of a partner's death, illness, disability, or desire to leave.

• The provision for determining the value of a departing partner's interest and method of payment of that interest

• The methods of setting disputes through mediation or arbitration

• The duration of the agreement and the terms of dissolution of the business

Sub Chapter S Corporations

The Sub Chapter S Corporation is a unique hybrid that can be structure like the Limited Partnership, but operates like a corporation. 

The Sub S Corp is a tax election that allows the owners the protection of a corporation, yet the tax advantages of a Sole Proprietor.  Tax losses and income are passed directly to the owners.  This avoids the double taxation associated with a standard C Corporation as it distributes dividends, which are taxable to both the corporation and the individual.  The S Corp can be converted to a C Corp relatively simply.  Changing from a C to an S is more difficult and there are limitations on these conversions.

Another disadvantage of an S Corp is that it cannot have C Corp or Partnership Stockholders.  This may severally limit your ability to raise funds from larger and more sophisticated investors.  The optimum strategy is to begin as an S Corp and use the initial tax losses to shelter income for you and your seed capital investors.  Once you have a larger investor or begin to become more profitable you can elect to change to a C Corp.

The S Corp also allows the company distribute both tax losses and profits in a manner that is uneven with respect to the different stockholders. Check with your attorney and CPA for detailed information.

I fact, the cost and complexity of the corporate legal structure make it an unrealistic option for many small businesses. Talk to your attorney or accountant to determine if this form of legal structure is right for your business.

The certificate of incorporation should usually have the following information:

• Corporate name of the company (should not be deceptive and should not conflict with the names of other existing corporations)

• Purposes of the corporation (should be broad enough to allow for expansion and specific enough to give a clear idea of the business to be performed)

• Length of time the corporation will exist (may cover a number or years or be "perpetual")

• Names and addresses of incorporators

• Location of the registered office of the corporation

• Proposed capital structure (state the maximum amount and type of stock your corporation wishes authorization to issue; state the amount of capital required at the time of incorporation)

• Management (state the provisions for the regulation of the internal affairs of the corporation)

• Director (provide the name and address of the person who will serve as the director until the first meeting of the stockholders)

The bylaws of the corporation may repeat some of the provisions of the charter and usually cover such items as the following:

• The location of the principal office and other offices

• The time, location, and notice of stockholder meetings

• Number of directors, their compensation, terms of office, method of election, and the filling of vacancies

• The time and location of director's meetings

• Quorum and voting methods

• Insurance and form of stock certificates

• Methods of selecting officers and of designating their titles, duties, terms of office, and salaries

• Method of paying dividends

• Decision regarding the fiscal year

• Procedure for amending the bylaws

Bibliography:

1. "Steps to Small Business Start-Up", Pinson, L. and Jinnett, J.

2. "Business Development and Funding", Venture Planning Associates