How to Choose the Right Business Entity
By Muhaisen & Muhaisen, LLC – Mark Malone, Esq. | September 17, 2019
How exciting. You are ready to implement your idea. Your business plan is in place and you’re ready to make it official. Now what? We do not recommend using an online service that quickly allows you to “incorporate.” The formation of a new business is a delicate situation that must be handled carefully and thoughtfully.
From the shareholders and partners involved in your business to the types of funding you can possibly receive down the line, your choice of entity plays a big role in the overall structure of your business. So it’s important to choose wisely. Keep in mind that entity selection doesn’t happen at the federal level; it’s state-specific and subject to the individual laws where you will be conducting business. In Colorado, the most popular entity is that of the Limited Liability Company (LLC).
The determination of what legal structure to use for a business should be based on how the business will be operated.
Questions to be answered include:
- Who will be the owners?
- What restrictions are desired for transfer of ownership interests?
- Who has ultimate control?
- How will the business be managed?
- How will the business derive its revenue?
- What tax issues should be anticipated?
- What assets will the business hold?
- What type of debt and equity financing is anticipated?
- What areas of potential liability pose the greatest risk?
All of these issues will have an impact on how the business should be structured
The Limited Liability Company (LLC)
The Limited Liability Company is a hybrid entity that allows the business to be taxed as a partnership or a corporation. Perhaps most appealing about an LLC is the fact that it provides the liability protection of a corporation while giving business owners options on how they would like to be taxed. LLCs are comprised of members, not shareholders. So long as corporate formalities specific to the state are observed, individual members will typically be protected from liability.
Benefits of incorporating as an LLC business include:
- Pass-through taxes: When it comes to federal taxes, an LLC business will usually be treated as a pass-through entity, making a corporate tax return unnecessary. Most LLCs are taxed as partnerships because it’s more beneficial. Owners can report their profit shares and losses on individual tax returns and, in the process, avoid double taxation.
- Limited personal liability: By definition, an LLC is considered a legal entity separate from the individual members and owners of the business. As such, the owner will not be held personally liable for debts or legal responsibilities of the LLC.
- Flexible sharing profits: Members of an LLC business have the unique ability to determine how profits will be allocated according to the terms specified in the LLC operating agreement. They are not limited by their proportion of ownership.
Sole Proprietorship – A sole proprietorship is an individual doing business as the sole owner of that business. 2 The sole proprietor is entitled to all of the profits and, broadly speaking, can enter and exit from the business as he or she pleases. This business is simple and informal, but there are drawbacks. The primary disadvantage for business owners operating as sole proprietorships is the exposure to unlimited personal liability
General Partnership – After two or more persons agree to carry on as co-owners of a business with the expectation of making a profit, those individuals have created a general partnership. Although not required, a written partnership agreement is preferable. Issues not dealt with in a partnership agreement are governed by the relevant state statute. In 1997 Colorado enacted the Colorado Uniform Partnership Act, which is codified at C.R.S. §§ 7-64-101 et seq. Management of the business is vested in all partners equally. The partnership is dissolved upon the death of any partner, upon agreement of the partners, or upon the occurrence of other events listed in the statute. Each partner is jointly and severally liable for all of the obligations of the partnership itself. In Colorado and certain other states, a general partnership may register with the Secretary of State to become a limited liability partnership to reduce certain liabilities to the partners. The partners of a limited liability partnership are not liable for partnership obligations.
Limited Partnership – As with a general partnership, a limited partnership is an association of two or more persons carrying on business as co-owners for profit. However, a limited partnership has at least one general partner and at least one limited partner. The partnership is formed by filing a Certificate of Limited Partnership with the Secretary of State. Limited partnerships date back to the Uniform Limited Partnership Act of 1931. They were designed to protect limited partners from any liability beyond their investment in the limited partnership, similar to the limited liability of a shareholder of a corporation. The evolution of the statutory law in most states now provides for the registration of a limited partnership as a limited liability limited partnership which, in essence, extends the limited liability protection to the general partners as well as the limited partners. The general partners of a limited partnership manage the business affairs of the partnership. For purposes of binding the limited partnership and conducting business.
Corporations are distinct legal entities created by filing Articles of Incorporation with the Secretary of State of a particular state. Ownership is vested in the shareholders of the corporation, and management is vested in the board of directors, which is elected by the shareholders. The Articles of Incorporation, together with the Bylaws, govern the corporation’s activities and management. The relationship of the shareholders to each other is often governed by the adoption of a shareholders’ agreement (sometimes referred to as a “buy-sell agreement”). Colorado is deferential to a corporation’s Articles of Incorporation and Bylaws with respect to the governance of the corporation in its ordinary course of business. Through its governing documents, a corporation may assign certain decisions to directors, officers, or even key employees, agents, or contractors of the corporation. As a separate entity, a corporation is subject to separate tax procedures and rates by the federal and state authorities. Unlike the sole proprietorship, partnership, and LLC, where income passes through to the individuals who comprise the enterprise, a corporation is taxed separately on its own income. This causes some advantages and some disadvantages, all of which must be considered carefully
Muhaisen & Muhaisen, LLC: Your Business Law Advocates in Denver and Colorado
The process of choosing a business entity is best done under the guidance of legal professionals who can help ensure you make the best decision for you and your company. At Muhaisen & Muhaisen, LLC, our Denver business litigation lawyers can help. With years of legal experience and proven trial track record to our name, we are one of Denver’s leading law firms for all business-related matters. And unlike most business lawyers, we can help you prevent problems, and also litigate for you in court if you have them.
Unwavering in our commitment to protecting the rights of business owners in Colorado, we can be relied upon to help with your case. Our trusted legal team handles business litigation matters of every nature, from breach of contract to shareholder disputes, and more. Contact us today to learn more.
Disclaimer: The information in this blog post (“post”) is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from Muhaisen & Muhaisen, LLC. or the individual author, nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of any information included in, or accessible through, this Post without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient’s state, country or other appropriate licensing jurisdiction