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| General Counsel Services |
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| Forming a Company |
  Sole
Proprietorship
General
Partnership
The need to limit liability
A threshold question for any startup business
is what legal form that business should take. The first question is whether
to establish an entity, typically a corporation or a limited liability
company. The obvious advantage of an entity is that it can limit the
liability of the owners to the amount of capital invested.
Without an entity an individual business owner's operation is a sole
proprietorship.
Two or more people who establish a business without an entity have formed
a general partnership.
Surprising though it may sound, there are often good reasons to start
a small business without an entity. For one thing, some of the risks can
be covered by insurance. In addition, even with an entity, the owners
may be required to sign personal guaranties. Landlords entering into commercial
leases with startup companies, banks granting loans and franchisors granting
franchise rights all typically require personal guaranties. This defeats
the limited liability protection at least vis-à-vis the beneficiaries
of the guaranties. On the other hand, the entity will protect the business
vis-à-vis customers, suppliers and others. The “Inc.” or “LLC” designation
adds a certain character to the business that may appeal to or even be
required by potential customers. It allows for continuity when the ownership
changes.
| Sole Proprietorship |
Without an entity, a business owned
by one person is a sole proprietorship. This is the simplest form
of business involving the least cost to establish. In New York ,
the proprietor files a business certificate in the county clerk's
office, files an application for employer identification number
with the Internal Revenue Service and opens a bank account in the
name of the business. Lots of people start businesses in this manner.
The business can always be converted into a corporation or limited
liability company at a later date. |
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| Partnership |
Two or more people can start a business in the
same manner. With no agreement, this arrangement would be a general
partnership. The addition of another person or people adds a factor
that all partners must consider carefully. Each partner is liable
for obligations of other partners. This means that each partner
must be very trusting to enter the partnership. Nevertheless, like
sole proprietorships, partnerships are common. One way to deal with
the risks of dealings with partners is to prepare a detailed partnership
agreement that sets forth the way in which the business will be
managed, the way that profits and losses will be allocated, the
withdrawal of partners, the transfer of partnership interests and
the admission of new partners, and similar subjects. The agreement
brings the partnership one step away from simply a trusting relationship
and establishes structure. It is also a good way to minimize the
likelihood of disputes and to establish a means of resolving disputes
when they cannot be avoided. |
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| The need to limit liability |
The clear limitation of both the sole proprietorship
and the general partnership is that they do not afford limited liability.
Sole proprietors and general partners are personally liable for
the debts of the business. This is a primary reason that many businesses
prefer to be organized as corporations or limited liability companies.
By operating the business through either one of these entities,
the liability of the owners is essentially limited to the amount
of capital invested in the company. |
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