You’ve found a great business idea and, after studying the market and your competition, you’ve developed what you know will be a popular and profitable product or service. The next and very important step is to create your ‘legal personality.’ This is your business structure and how you will register it at the proper government agency—the company equivalent of a ‘birth certificate.’
In a nutshell, your ‘legal personality’ is the format or structure that the law and the public will recognize. Traditional choices include sole proprietorship, partnerships, and corporations. Here is a simple overview.
1. Sole Proprietorship
If you are going to run the business yourself then this is the best format for you. You retain absolute control over your company, and are not answerable to a partner or a board of directors.
There are obvious pros and cons to this kind of business structure. As the ‘Big Boss’ of your company, you can act swiftly, unencumbered by the kind of negotiating (and arguing) that often comes with working other people. You can grab opportunities, make deals, and make important decisions on hiring, firing, outsourcing, etc.
However, as the sole proprietor, you also carry all of the burden of finding investors and managing the costs. Legally, your business identity is not separate from your personal entity. If any individual or company wants to file a claim against your company, they can run after you. So if your business fails, and you’ve racked up a great deal of debt with suppliers, they can seize your assets.
The good news, though, is that filing taxes is infinitely easier. You can combine both the income of your company and other alternative income sources under your personal taxes. Plus, you get to keep all of the profits.
In partnerships, the company is run by two or more people. Many entrepreneurs enter into partnerships to generate more capital for the business or to combine strengths (for example, the ‘creative’ person will take care of developing the product, while the ‘sales and marketing’ person will handle getting it out on the shelves). Some first-time entrepreneurs are also more comfortable sharing the decisions with somebody else.
The downside, however, is that any partnership can lead to interpersonal conflicts, which if not handled properly (and anticipated and prepared for by a solid business agreement) can compromise the success of the business. There are many stories of companies stagnating or dissolving because partners no longer saw eye-to-eye on important decisions.
Legally, a business partnership is seen as a separate entity from the people who run the company. You will open a bank account and hold business transactions under a separate company name. All profits will go to that account, and then be divided according to the proper ‘share’ as stated in the business contract. However, debts and liabilities are also divided according to the proportionate share. So, if you owe $50,000 and only have a 50% stake in the company, than other individuals or companies can only seize $25,000 worth of your personal property.
Partnerships will require an Article of Partnership contract that lists any agreements you have among yourselves. At its most basic, it will cover the name of the partnership, the names of the partners, the contributions, and share of profits and losses. However, you can also include details like the division of tasks, or provisions about what to do if a partner quits or wishes to dissolve his share.
You can also get a Limited Partnerships (signified by the word ‘Ltd.’ after the company name) or arrange for others to be a managing partner instead, which will allow you to retain greater control over company decisions and business direction.
Corporations are considered a completely separate legal entity from the stockholders. This means that if individual or company wants to file any claims against it, you are protected. Your only liability or risk is the money you invested in the corporation.
Corporations obviously offer the best legal protection, but you need to know—this type of business structure is remarkably tedious and expensive to file. You’ll have to keep a stock and transfer book, a stock certificate book, minutes of the meetings with the board of directors, and annual audited statements. The taxes of corporations are also higher than the taxes of single proprietorships, and are separate from the taxes you will file on any income you get from the company.
There are also minimum requirements for number of employees, company members, and board of directors.