Understanding Ownership and Business Entity Structures 3
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Do we need an attorney to write the partnership agreement?
It is advisable to have an attorney to draw up the partnership agreement.
Are there partners who just contribute money and don't get involved with the business at all?
Yes. Usually that kind of arrangement is set up as a limited partnership and specifically spells out when and how and under what terms the investor(s) will get back their money. It is frequently used for financing small businesses. Limited partners are not liable for debts or actions of the partnership; the most they can lose is the amount they invest.
How does a corporation differ from a partnership?
A corporation is a legal "person." In other words, it has an identity that is distinct and separate from the individuals who own the corporation. Like a real person, the corporation is legally entitled to enter into contracts, conduct business, own property, lend or borrow money, and so on.
What are the advantages of incorporating?
The primary benefits of operating under a corporate form generally revolve around tax and marketing considerations and ease of attracting investors. In real life, while the benefits of incorporation may technically be available to a business of any size, in practice very small businesses may gain little or no benefit by incorporating until they have employees or can reap tax benefits by incorporating.
That said, these are the potential benefits of the corporate form of business:
- You may be able to raise capital more easily as a corporation than as a sole proprietor; however, there are no guarantees.
- It may be easier to transfer ownership in a corporation than it is in a sole proprietorship or a partnership.
- Under some circumstances your tax rate might be lower.
- If you have employees, incorporation may protect your personal assets if an employee does something that causes the company to be sued.
- You may be able to give yourself more company-paid fringe benefits as an employee of your corporation.
- You may be able to get and keep good employees by offering them stock in the company.
- You may gain estate-planning benefits.
- You might find incorporation preferable to a partnership if you will be going into business with one or more other people.
What are the disadvantages of incorporating?
Among the disadvantages of incorporating are:
- Your cost of doing business usually increases due to added fees you have to pay.
- The amount of paperwork you have to do increases because of legal record-keeping requirements.
- You may be subject to "double" taxation, having your profits taxed once at the corporate level and once again as an individual.
- The IRS could limit your salary as an employee of your own corporation to an amount it considers reasonable and treat amounts above the "reasonable" salary to be dividends.
- Your personal finances must be kept completely separate from the corporations finances. Thus, you can't dip into the corporate bank account if you come up a little short on personal cash for the week.
- Closing the corporation's doors permanently can be somewhat complicated and costly.
Doesn't the corporate form of business protect your personal assets?
No, it won't necessarily protect your personal assets. Here's why: Even though you, as a shareholder of your own corporation, may not be responsible for the debts of the corporation (since the corporation is a separate "person"), there is nothing to prevent someone from suing you personally for actions you performed. For instance, suppose you personally created an ad campaign for your corporation criticizing a competitor. The competitor views the campaign as malicious and untrue and decides to sue. They might sue your corporation and you, personally, as the creator of the ad. While you would not be liable for any settlement the corporation has to pay as a result of the suit, your personal assets could be attached to pay off any judgment the competitor won in its case against you the individual.
In addition, even though you might not technically be liable for the corporation's debts, if you owned a very small corporation, chances are you would have to dig into your own personal bankroll to come up with the money to fight the lawsuit.
Thus incorporation does not necessarily prevent liability problems. One important step you can take to help protect your assets against loss is to obtain adequate liability insurance (business property, professional errors and omissions, and product liability).
The other fallacy about incorporation is that somehow it protects you from paying off any bad debts the corporation incurs. But things rarely work that way. While you are not automatically responsible for the corporation's debts the way you would be responsible for your sole proprietorship or partnership debts, rarely will you be able to get a loan for a new small corporation unless you sign a personal guarantee, which means that you, personally, will have to pay back the loan if the corporation defaults. You may also have to sign personal guarantees on building or equipment lease agreements.
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