Make Sure Business Is Structured Carefully

The legal system can be fascinating and overwhelming to the non-lawyer. Just consider how many ways two people can engage in a business. We’ll explain some of the basic legal structures that can be used to own a business.

A typical and customary way is for two people to become partners. They can be general partners, with each having the right to control the day-to-day business and share in the results of their work as set forth in the partnership agreement.

Or they can form a limited partnership, with one a general partner and the other a limited partner. The limited partner has exactly what the name implies, limited control over the business operation and limited liability if the business goes under.

You can even have a partnership between an individual and a corporation. Or two corporations can form a partnership to conduct business.

Two people can work together as employer and employee. The employer or the owner of the business can give the employee a percentage of the profits, but the employee does not share the risk of loss if the business goes sour. The sole owner can form a corporation to own the business, so the corporation has the risk of loss, and not the owner personally.

If the only property of the partnership is real property (land, vacant or improved), you might consider owning the property as tenants in common, essentially sharing your ownership, with each of you having the right to dispose of your interest by sale or through inheritance. If it is a business venture, you probably don’t want to own the property as joint tenants because upon the death of the first partner, the survivor owns it all.

If you really want to complicate things, try a partnership between an individual or a corporation on the one hand, and a trust on the other hand.

There is also an “S” corporation. In general, with a corporate ownership structure, the shareholder’s wealth is protected from liability from the losses of the corporation, and the shareholder does not pay income tax on the profits of the corporation, but pays based only on what he or she receives in dividends. With an S corporation, for tax purposes, the earnings of the corporation run through directly to the shareholders, much like a partnership, and the shareholder must pay income tax on those earnings.

There is a new wrinkle available in several states, called the Limited Liability Company (LLC). An LLC is a partnership with a provision limiting the liability of the partners. As to liability, it works like a corporation. An individual owner’s assets are not on the line if the ventures goes belly-up, only the assets of the enterprise. But when it comes to income taxes, the owners of an LLC are treated like partners and pay taxes on the income of the enterprise. California does not have any statutory provision for LLCs, but on last count, there were 18 states that allowed them.

This is merely an overview of the various ways in which business partnerships can “legally” exist. Each has a vast array of legal, financial and business details that must be reviewed when deciding how to run your new business. Lawyers and tax advisers can be quite helpful. Whatever you do, if you are entering business with another, whether it is a friend or business colleague, you should put in writing your understanding of each of your rights and obligations. Also, remember that most business ventures do not exist forever, and you should provide a framework for terminating the business.