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Legal VIEW

Select a Format for Your Own Business

September 11, 1986|JEFFREY S. KLEIN

Many people dream of being their own boss and running a small business. The dream usually has you sitting on the beach in Tahiti because the wildly successful, well-oiled operation you started now runs itself, thanks to the excellent staff you hired and the policies and procedures you put in place.

Long before you ever make it to the beach, even before you wrestle with the daily headaches of operating a business--the employee turnover, theft, faulty equipment or changing customer tastes--you will have to wrestle with a lawyer and an accountant.

You will have to decide what legal form the business should take. You usually have three basic choices: sole proprietorship, partnership or corporation. Each one has advantages and disadvantages, depending on the nature of the business, tax considerations and management and control issues.

A sole proprietorship is the law's way of saying that the business is yours, all yours. You have complete control. Whether you operate the business under your own name, say as Johnny's Hamburgers, or with a name you've created, such as Hamburger Delight, if it is a sole proprietorship, everything the business makes is yours to keep and everything it loses is yours to pay.

If the business can't make enough money to pay the bills, if you don't sell enough hamburgers to pay for the buns you ordered, then you are personally liable to pay the bills yourself. If a customer slips and falls on a French fry and wants to sue someone, you will be the someone who will be sued. And your personal assets, not just the assets of the business, will be at stake.

Must Comply With Rules

If you do start a business as a sole proprietorship, you still have to comply with all state and local rules and regulations and you must obtain the proper permits. In addition, you should file a fictitious business statement, which requires that you publish a legal notice explaining that you are operating the business, the name of the business and that you are the person responsible.

A general partnership is similar to a sole proprietorship in many ways except that you have joined with one or more persons to operate the business. Each partner shares losses, profits and expenses. The split does not have to be equal. You can divide the proceeds by agreement. Although it is not required by law, every partnership should have a written agreement that describes how profits and losses will be allocated, how the partnership can be terminated, what happens if one of the partners dies or becomes incompetent, how the business will be managed and numerous other essential terms.

In general, you are bound by the actions of your partners as long as they are part of a usual partnership business. In other words, if the partnership operates a shoe store and your partner orders a new shipment of pink-and-blue-striped tennis shoes without your permission, the partnership will probably have to pay the bill. And that means you will personally be on the hook to pay the shoe manufacturer if the partnership does not have enough money or your partner skips town.

On the other hand, if you are a limited partner in the same deal, your liability for the tennis shoes will be limited to your investment. That's the crucial difference between a limited partnership and a general partnership. In a limited partnership, there is a general partner who is responsible for the control and operation of the business, and the limited partner is a passive investor. The limited partner is only liable up to the amount of his investment. You can lose your entire investment, but won't have to pay off the partnership's debts as you would if you were a general partner.

Finally, there is the corporation. The primary legal advantage to corporate form is limited liability. Assuming that a corporation is operated properly and meets financing and technical requirements, its owners, the shareholders, are, like limited partners, only liable up to the amount of their investment.

Officers Are Elected

A corporation can be owned by hundreds of thousands of shareholders or just one. The shareholders elect officers who operate and manage the company's business. Corporations are treated by the law as a legal entity, a person. A corporation is separate from its owners; it can sue and be sued, buy and sell property, loan money or file for bankruptcy.

Should you incorporate the family business? That will require registration with the state Secretary of State, the drafting of bylaws and other formalities that usually require the assistance of a lawyer and accountant. You may benefit by limited liability, but you will also have to assess the tax implications. You could be taxed twice. The corporation pays taxes and then you will be taxed again on any profits that are distributed to you in the form of dividends.

Your lawyer and accountant should be consulted to determine which legal entity is best for you.

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