Overview of Starting a Business
The principal forms of business operations are (1) sole proprietorships, (2) general partnerships, (3) limited liability partnerships, (4) limited partnerships, (5) family limited partnerships, (6) limited liability limited partnerships, (7) limited liability companies, (8) Subchapter C Corporations, (9) Subchapter S corporations, and (10) professional service corporations and professional liability companies. There are at least three significant considerations when deciding how to structure most small businesses: (1) the number and relationship of the principals involved; (2) the nature of the business; and (3) the present size of and the reasonably anticipated growth potential of the business.
Nature of Business and Assets
While certain types of businesses historically were found in certain entities, the distinctions are becoming less important, so that today nearly any business may be suited for nearly any entity. A critical issue in any combination of business and assets with an entity is limited liability. For instance, a business involving hazardous real estate, hazardous products, or other high risk of liability should not be operated as a sole proprietorship or general partnership.
Other entities, such as subchapter C and S corporations and limited liability companies, may be suitable for a wide range of businesses. As your attorneys we will discuss the details of the anticipated business and its assets to help you select the most appropriate entity. The entity most common in the industry may become an important factor in selecting the entity; it is likely there are good reasons that the entity is the most common.
For example, if competitors are all partnerships, persons entering the industry as a subchapter C corporation may encounter, in addition to the tax disadvantage, significant drawbacks which may not be known until the business begins operating. Real estate development historically has been conducted through a limited or general partnership, but with the increasing importance of environmental contamination concerns, “pass through” entities that limit liability are becoming more popular.
Size of Business or Investment
The entity we would recommend for a $5,000 startup business to be owned by a single person or a couple will be quite different from a $2 million startup investment by three unrelated persons. The anticipated initial amount third-party debt may dictate a partnership or limited liability company structure as opposed to a corporate structure. Generally, the larger the initial investment and the larger the future entity, the more complex and detailed the entity will be. Some entities are better suited to deal with the myriad concerns that a larger investment entails.
Although one cannot foretell the future growth of any particular business, one can often determine the reasonably anticipated growth of a new business before it is organized. In fact, any good business person will analyze the industry before starting the business to determine its reasonably anticipated growth potential.
For a business that can reasonably anticipate only modest growth (e.g., a family livelihood business), a limited entity structure may be acceptable. On the other hand, a business that can reasonably expect rapid and expansive growth must be in an entity that facilitates growth. Ease of acquisition of new investors or new creditor financing may be critical.
An entity that must be abandoned or significantly changed to accommodate growth can be prohibitively expensive and will likely cause an interruption of the business just when key management needs to focus on the growth of the business. While today most business entities can be changed as the business grows, the cost and inconvenience of these changes can often be avoided if thoughtful and well-documented planning is done before choosing the entity.