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As we all know, business is conducted under a variety of old,
new and ever-changing forms. However, still the three basic forms are sole
proprietorships, partnerships, and corporations. Many hybrid forms also exist, e.g.
limited partnerships, S corporations, Limited Liability Companies, and Limited Liability
Limited Partnerships.
When considering which of these organizational alternatives is best
suited for you, your new or changing business, please consult competent professionals. No
one form of organization will be appropriate for all occasions, and as business expands
change may be necessary.
In making this decision you should consider a variety of factors
including: complexity and expense of organizing the business; liability of the business
owner,; distribution of profits and losses; management control and decision making;
financing startup and operation of the business; transferability of ownership interest;
continuity of the business entity following withdrawal or death of an owner; complexity
and expense of terminating the business; extent of governmental regulation; and tax
consideration.
In Minnesota, you may want to contact the Minnesota
Secretary of State's Office especially
their Business Services
site.
Findlaw Small
Business Legal Structures
1. ORGANIZATIONS: DEFINITIONS
A. SOLE PROPRIETORSHIP
A sole proprietorship is a business owned by only
one person. The business' property belongs to that person and any income or loss are added
to or deducted from that individual's personal income for tax persons. Any debts owed by
the organization are debts of the proprietor. Because of its inherent limitation to one
owner, the sole proprietorship cannot be a choice when more than one person wants to own a
business.
B. PARTNERSHIP
A general partnership is created by an agreement between two
or more persons to operate a business and to share profit and losses. Partnerships have
specific attributes which are defined by statute. All partners share equally in the right,
and responsibility to manage the business, and each partner is responsible for all the
debts and obligations of the business. Distribution of profits and losses, allocation of
management responsibilities, and other issues affecting the partnership are defined in a
written partnership agreement. The partnership itself in not a taxable entity, but income
and expenses of the partnership are reported on federal and state "information"
tax returns, which are filed by the partnership. The partners are taxed on their
respective share of the partnership's profits at their individual income tax rates.
C. LIMITED PARTNERSHIP
A limited partnership is a type of partnership in
which the limited partners share in the partnership's liability only up to the amount of
their investment in the limited partnership. By statute. the limited partnership must have
at least one general partner and one limited partner. The general partner has the right
and responsibility too control the limited partnership. The limited partner, in exchange
for limited liability gives up the right to participate in the day-to-day management and
control of the business. Limited partnerships must be established in compliance with
statutory requirements, including requirements of tax and securities laws. Because of
their complex nature, limited partnerships should not be undertaken without competent
professional advice.
D. CORPORATION
A corporation is an artificial, intangible person
or being which is owned by one or more shareholders. The corporation must be established
in compliance with the statutory requirements of the state of incorporation. The
shareholders elect a board of directors which has responsibility for management and
control of the corporation. Because the corporation is a separate legal entity, the
corporation, and not its shareholders generally is responsible for the debts and
obligations of the business. In most cases, shareholders are insulated from claims against
the corporation.
E. THE CLOSELY HELD CORPORATION
A closely held corporation is one whose shares are
held by a relatively small number of shareholders, in Minnesota not more than 35
shareholders. Most closely held corporations are relatively small business enterprises, in
which are shareholders tend to be active in the management of the business. It can provide
many of the advantages of incorporation, such as limited liability for shareholders and S
corporation status for tax purposes, while retaining many of the simplified, less formal
operating procedures of sole proprietorships and partnerships. allows shareholders to a
corporation to elect to have their corporation taxed like a partnership.
F. THE LIMITED LIABILITY COMPANY
A Minnesota business may organize as a limited liability
company, a form that combines the tax treatment of a partnership with the limited
liability characteristics of a corporation. Like a partnerships, business income and
losses of the limited liability company are passed through to the owners of the business.
Like a corporation, liability for business debts and obligations generally rests with the
entity rather than the individual owners. A LLC is not taxed at the entity level,
eliminating the double taxation of profits that occurs with a C corporation. Income is
taxed at the owners' individual tax rate. A LLC is not subject to many of the restrictions
that apply to S corporations, e.g. max of 35 shareholders, a single class of stock, and no
non-individual shareholders. Unlike a limited partnership, a members of a LLC may
participate in the active management of the company without risking loss of limited
personal liability. A LLC must have at least two members, and is managed by a board of
governors and at least two active members.
G. OTHER FORMS OF ORGANIZATION
Other forms of organization available in Minnesota businesses
include: professional corporations, cooperative associations, business trusts, and
permutations on such themes These types of organizations are established and regulated by
statute and involve complex legal, financial and accounting issues
2. THE ENTITY ITSELF
A. PARTNERSHIP
The partnerships is not a separate entity for the individual
partners. They are considered one and same for purposes of suing and being sued.
B. CORPORATION
The corporation of the other hand is separate legal person from its
shareholders, directors and officers. This is true even if there is only one
shareholder.
3. PERSONAL LIABILITY OF THE PARTNERS OR SHAREHOLDERS
A. PARTNERSHIP
Each general partner is personally liable for the full amount
of the partnership's obligation. In the case of a limited partnership, the limited
partner is only liable to the amount of his contribution of the partnership. This is
because the limited partner takes no active role in the day-to-day running of the
partnership.
B. CORPORATION
A shareholder is not personally liable for the obligations of the
corporation and risks only the loss of his or her investment. However, in a small closely
held corporation, especially in today's market, shareholder may have to give up this
protection voluntarily, that is, as a prerequisite of getting a loan the bank may
require that the shareholders personally guarantee the repayment of specific loan.
C. LIMITED LIABILITY COMPANY
As with the corporation, no personally liability unless the
corporate veil is pierced.
4. CONTINUITY - HOW LONG DOES IT EXIST?
A. SOLE PROPRIETORSHIP
Upon the death of the sole proprietor
B. PARTNERSHIP
Generally, the partnership terminates on the death or withdrawal of
any of the partners. However, it is possible to avoid this by putting in the partnership
agreement a pre-arranged provision for the continuation of the business if one of the
partners dies or leaves. This will also change with RUPA in Minnesota in 2002
C. CORPORATION
A corporation may be organized for perpetual existence, so it's
continuity is unaffected by the death or withdrawal of individual shareholders, even
though there may be practical risks involved.
D. LIMITED LIABILITY COMPANY
Disassociation of a member threatens dissolution unless remaining
members consent to avoid dissolution with a "business continuation agreement
(BCA)."
5. MANAGEMENT AND CORPORATE GOVERNANCE
A. SOLE PROPRIETORSHIP
Sole Proprietor makes the decisions
B. PARTNERSHIP
All general partners share equally in the right to, and the
responsibility for, the management of the business. This responsibility applies equally to
those partners who chose not to exercise their management rights, e.g. "silent
partners." But it is possible, by a provision in the partnership agreement, to
centralize the management in a management committee.
C. CORPORATION
The Board of Directors have the basic management rights, and beyond
electing the board of directors, the shareholders generally have little or no management
rights or responsibilities.
D. LIMITED LIABILITY COMPANY
Governors are elected who have the management duties.
6. TRANSFERABILITY OF SHARES
A. PARTNERSHIP
Generally, under partnership law, no person can become a partner
without the consent of all the other partners. And even if such consent is obtained, a new
partnership agreement is required which would then include the new partner. It is possible
to avoid these problems by placing in the partnership agreement a prearranged provision
where the partners agree in advance to the substitution of a new partner under specific
conditions. This has the affect of making, at least in a limited sense, the interest in
the partnership transferable.
B. CORPORATION
Shares in a corporation are freely transferable, so they can be
bought and sold easily. However, in a closely held corporation, it is possible and
sometime preferable, to severely limit the transferability of the shares, for example,
"Buy-Sell" agreements, where if a shareholder wishes to leave the corporation,
she must first offer her shares back to the corporation or to the other shareholders, who
have the right of first refusal.
C. LIMITED LIABILITY COMPANY
Financial rights of all members is freely transferable, by the
transfer of governance rights and complete membership interests require unanimous consent.
Entity terminates if more than 50% of the capital and profits are sold in a 12 month
period.
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