Selection of Business Entity
The initial decision faced in starting a new business is
the selection of the form in which the business will operate.
Generally, a business may be conducted as a sole proprietorship,
a general or limited partnership, a corporation, a limited
liability company, or as one of several special sub-structures,
such as a limited liability partnership, professional service
corporation or a sub-chapter S corporation. Huck Bouma PC can provide expertise in any of
these forms of business. Some common business forms are briefly
outlined in this publication.
Sole Proprietorship
- DBA
General
Partnership
Limited
Partnership - L.L.P.
Corporation
- “S” Corp
Limited
Liability Company
THE SOLE PROPRIETORSHIP
A sole proprietorship
is generally the one-person ownership of a business. It is
easy to form since no organizational documents are required
to start the business. Although in some cases an “Assumed
Name” filing is necessary in order to form a sole proprietorship,
this business form can be operated entirely without the formalities
of shareholder meetings or the election of directors. Legally,
the sole proprietor-ship does not exist separate and apart
from its owner. Although the sole proprietor is entitled to
all of the profits and owns all of the assets of the business,
the sole proprietor is also personally liable for all debts
and obligations of the business. Termination of the sole proprietorship
is very simple, as no transfer or termination documents are
required.
GENERAL PARTNERSHIP
The general
partnership is the most common alternative to incorporation
for businesses involving more than one individual. It is formed
when two or more persons or other legal entities associate
for the purpose of operating a business and sharing profits.
It is advisable for partners to execute a partnership agreement
to govern operation of the business; otherwise, potentially
unfavorable state law default provisions will control. A general
partnership does not itself constitute a legal entity separate
from the partners. Partners share in the profits and assets
of the business and are personally liable for all business
debts and obligations. In this regard, the general partners
are jointly and severally liable for the partnership’s obligations.
A general partnership is technically dissolved under a variety
of circumstances, including the death or withdrawal of a general
partner. Upon the death or withdrawal of a general partner,
the remaining general partners ordinarily may continue the
partnership business, although technically a new general partnership
has been formed. This is one of the many areas in which a
well drafted partnership agreement will provide operational
and tax benefits. In Illinois, general partnerships are governed
by the Uniform
Partnership Act (UPA). In the absence of contrary provisions
in a partnership agreement, the UPA will govern the operation
of a general partner-ship. Illinois also allows limited liability
partnerships (LLP’s). If a general partnership elects to be
registered as an LLP, individual partners will not be jointly
and severally liable for the negligence of other partners.
However, each partner will remain personally liable for the
liabilities of the partnership arising from his or her own
negligence or misconduct.
LIMITED PARTNERSHIP
The limited
partnership is similar to the general partnership in many
ways. Unlike a general partnership, however, some formality
is required to form a limited partnership, as a certificate
of limited partnership must be filed with the Secretary of
State. Every limited partnership must have at least one general
partner and one limited partner. The general partner has unlimited
personal liability for partnership liabilities, but may participate
in the management of the business. A limited partner’s liability
for partnership obligations is limited to the amount of his
or her capital contribution, but he or she may not participate
in the management of the business without causing a forfeiture
of that limited liability. A common practice is for a corporation
to act as the general partner, with individual investors retaining
only limited partnership interests in the project. Limited
partnerships are authorized and regulated in Illinois under
the Uniform Limited Partnership Act (ULPA).
CORPORATION
A corporation
exists as a separate legal entity from its owners. The corporation
offers owners of the business the best protection against
personal liability. It results in owners (shareholders) having
limited liability and provides for centralized management,
freely transferable interests, and continuity of existence.
The liability of shareholders is limited in that only the
assets contributed to and owned by the corporation are at
risk for corporation obligations. The creation of a corporation
must be in compliance with the Business Corporation Act of
Illinois. This is accomplished by filing Articles of Incorporation
with the Secretary of State and recording the Articles of
Incorporation in the county in which the corporation’s registered
office will be located. The corporation must also adopt written
bylaws, which generally govern the internal operation of the
corporation. The owners of a corporation own shares of stock
and have the right to elect directors. Directors are responsible
for formulating the general policies of the corporation and
electing corporate officers. Officers are responsible for
the day to day operations of the business. Directors and officers
have a fiduciary duty to act in the best interests of the
corporation and its shareholders. The corporate form also
more easily allows for transfer of ownership interests. The
major disadvantage of the corporate form is that it requires
the observance of certain formalities and therefore necessitates
greater administrative expense than do non-corporate forms.
If limited liability is an overriding consideration and if
certain risks are not insurable, either because of unavailability
or cost of insurance, the corporate form is an attractive
business entity. Some corporations may elect “S” corporation
status in order to achieve the “flow-through” tax benefits
available to partnerships.
LIMITED LIABILITY COMPANY
A limited
liability company (LLC) is a hybrid form of business entity.
An LLC combines the personal liability shield of a corporation
with the benefit of being taxed like a partnership. The LLC
is also allowed more flexibility than an “S” Corporation.
For taxation purposes, income and losses flow through to members
of the LLC, so that members are taxed personally on their
share of profits and can use their share of losses to offset
income from other sources. The creation of an LLC must be
in compliance with the Illinois Limited Liability Company
Act. This is accomplished by filing Articles of Organization
with the Secretary of State and by executing an Operating
Agreement which generally governs the internal operations
of the LLC. LLC’s provide tremendous flexibility in terms
of management structure and operations. LLC’s can be managed
by one or more managers, or they can be managed by all of
the owners. LLC’s can also establish different classes of
members with different voting rights.
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