Choosing the Best Legal Structure for Your Business

Sole Proprietor

What it is:

A sole proprietor is the simplest form of business structure with 1 owner. A sole proprietorship is not a separate legal entity. 

Requirements to create it:

Only minimal paperwork or filings are required. If you intend to operate under a name that is different from your own, you must file a Certificate of Assumed Name (often referred to as a "DBA" meaning 'doing business as') in the county or counties where you intend to do business. 

Liability:

For a sole proprietor, there is no legal separation between the business and the owner. Therefore, the owner will be personally liable for all business debts and the owner's personal assets (like a house or car) can be sought by creditors for repayment of any debts owed. 

Management & Control:

The business owner manages and controls the business.

Possible Advantages:

It is the easiest and least expensive form of business to start and requires little to no filings with the government. 

Possible Disadvantages

The biggest disadvantage is the absence of limited liability. All personal assets of the owner are at risk if the business can't repay its debts or is subject to a lawsuit. 

General

General

General
Partnership

What it is:

A general partnership is formed when 2 or more owners/partners agree (formally or informally) to carry on a business together.

Requirements to create it:

No paperwork or filings are required to create a general partnership. However, while a written partnership agreement is not required, it is highly recommended to allocate rights and responsibilities between the partners. The cost to have an attorney prepare an agreement will depend on the number of partners involved and the structure/complexity of the business.

Liability:

All partners are jointly liable for the their own acts and the acts of all other partners and each is personally responsible for the debts of the business.

Management & Control:

All partners have the right to manage and control the partnership unless otherwise agreed in the terms of a partnership agreement.

Possible Advantages:

Easy and inexpensive form of business to start with more than 1 person.

Possible Disadvantages

There is no limited liability for the partners in a general partnership. All personal assets (such as homes, cars, or personal bank accounts) are at risk if the business can’t repay debts or is subject to a lawsuit. Not likely to be attractive to passive investors so not a good vehicle for raising capital.

Limited

General

Limited
Partnership

What it is:

A limited partnership consists of 1 or more “general” partners and 1 or more “limited” partners who agree to carry on a business together and file the correct paperwork with the State.

Requirements to create it:

Must file a Certificate of Limited Partnership with the Secretary of State. A written partnership agreement is not required, but it is highly recommended to allocate rights and responsibilities between the partners. The cost to have an attorney prepare an agreement will depend on the number of partners involved and the structure/complexity of the business.

Liability:

The “limited” partner is not personally liable for business debts, while the “general” partner is personally liable for all business debts.

Management & Control:

The limited partner is typically a passive investor and is not allowed to participate in the management of the company (and would risk losing his or her limited liability status by doing so). The general partner manages the company and controls the day-to-day decision making.

Possible Advantages:

A limited partnership may be attractive to passive investors, particularly with real estate ventures and tax-advantaged investments.

Possible Disadvantages

The main disadvantages are the lack of limited liability for the general partner and not being as attractive to venture capital and private equity investors due to the lack of management control.  

Limited Liability Company

What it is:

A limited liability company is a hybrid legal entity between a corporation and a partnership consisting of at least 1 member/owner.

Requirements to create it:

The member(s) must file Articles of Organization with the State. A written Operating Agreement is not required, but highly recommended. An Operating Agreement lays out the rights and responsibilities of the members and governs how the company will be run. The cost to have an attorney prepare an operating agreement will depend on the number of members, the complexity of the business, and the desired capital and management structure.

Liability:

Members are not personally liable for the debts of the business. Therefore, the risk is limited to the amount of a member’s investment in the company.

Management & Control:

Management of the LLC is very flexible. Members can elect to govern the company themselves, or appoint 1 or more managers to manage the business of the company.  

Possible Advantages:

The LLC structure has become especially attractive to venture capital and private equity investors due to the structural flexibility and the ability to actively engage in the management of the company without risking their limited liability status. There are also less formalities and bookkeeping required than there would be with a corporation.

Possible Disadvantages

Limited liability companies are still a relatively new form of business entity so some investors may be more familiar or comfortable with investing in corporations.

Board

Officers

Corporation

What it is:

A corporation is a limited liability entity owned by shareholders and managed by directors and officers.

Requirements to create it:

An incorporator must file Articles of Incorporation with the State. Other requirements typically include drafting and adopting bylaws, a Statement of Domestic Stock Corporation, issuing shares of stock, and holding an initial meeting to elect directors, appoint officers (President, CEO, Secretary, etc.) and adopt bylaws. It may also be desirable to draft a Shareholders Agreement to govern the buying and selling of stock by shareholders.

Liability:

Shareholders are not personally liable for the debts of the business. Therefore, the risk is limited to the value of the shareholder’s investment (shares) in the corporation.

Management & Control:

The board of directors determines the high-level policies and corporate actions for the corporation. The board appoints officers to manage day-to-day affairs. Management is highly centralized and can be altered by stock classes, voting rights, and shareholder agreements.  

Possible Advantages:

Corporate entities are the most well-understood by investors and therefore have often been favored by investors historically. However, limited liability companies have become increasingly popular because of their other advantages over corporations.

Possible Disadvantages

More rigid management structure, additional bookkeeping, record-keeping, and government filing and reporting requirements.