Types of Business Structures
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Colorado and Wisconsin have a reputation for being two of the best places to start a small business, and with rents and interest rates at their lowest in years, now could be the time to start one. The vast majority of businesses are classified as “small” but they still account for more than 50% of all employment in the state. Nevertheless, there are legal aspects to opening a business that need to be addressed. First, you will need to consider what sort of business structure your business will take. The types of businesses is relatively small, but each one has advantages and disadvantages. Here is a brief list of legal structures.
- Sole Proprietorship: this is simply a business that is owned and operated by one person, and is considered the least complicated. For tax purposes, all income is reported as personal income which makes for easier accounting costs. Naturally, as sole owner, you will have total control over the day-to-day operations and will have no investors to report to. The main drawback is that any liabilities the business incurs will become the personal responsibility of the business owner, which means that if you find yourself in debt, your creditors can put a lien against your personal property, including your home. In Wisconsin, S Corporation status gives you the liability protection of a corporation, and allows you to pay taxes on the same basis as a sole proprietor or partnership, that means you pay tax at the personal rate and your profits are your salary.
- General Partnership: in Colorado a business owned by two or more people. As a rule, the partners usually draw up a contract delineating the responsibilities of each partner and how they will divide the profits. General partnerships have the advantage of allowing people with various strengths to put their heads together in the business. Remember, however that all liabilities are the responsibility of all the partners, which means if one partner stops “pulling his weight”, the other partners will still be 100% responsible. The laws in Wisconsin are similar.
- Limited Partnership: the same as a general partnership, but some of the partners may have limited liability protection. In most cases, the limited partners will only be liable for their cash investment in the business. Limited partnerships are good if a business needs an external cash infusion, but keep in mind that if the limited partners work the business with the general partners, they may lose their status of limited liability.
- Corporation: a corporation is different than the business structures above in that it is a distinct legal entity. The corporation in turn is owned by shareholders who usually hire executives and managers to run the business. Since the corporation is a thing unto itself, all debt and liabilities are the responsibility of the corporation, and not the individuals who own shares. This has the advantage of separating the financial interests of the owners from the business’s interests, but since a corporation is a legal entity unto itself, it must also pay its own taxes. This means the corporation pays taxes and the shareholders must pay taxes also as personal income.
- S Corporation: an S Corporation is run like a regular corporation, but it has no separate tax liability, and is taxed like a single proprietorship or partnership. In fact, an S Corporation is really a special type of corporation in that you must first be classified as a corporation before filing for S Corporation status. There are however, certain restrictions. The number of shareholders is limited to 75, you may not issue preferred stock, and there are additional bookkeeping restrictions that will apply.
- Limited Liability corporations: essentially a hybrid of partnerships and corporations. It is taxes like a partnership but liable like a corporation. In Colorado, LLCs are considered partnerships if they have more than one owner, and a sole proprietorship if it has one owner. The problem is that LLCs are more complex, and often the tax structures of the individual states may conflict with those of the federal government. If you are considering a LLC, it is advisable to contact an attorney. In Wisconsin, statute 183.0102(16) defines an Operating Agreement as “an agreement in writing, if any, among all of the members as to the conduct of the business of a limited liability company and its relationships with its members.” Specifically, the names of the members of the LLC are recorded in the Operating Agreement. The Operating Agreement is maintained by the members of the LLC. It is not filed with the Department of Financial Institutions, and we do not have a form or template for the document. You may want to conduct an internet search to locate more information and sample forms.
There are a number of other subtypes and hybrid business structures, but these are the most important. After you have decided which type of business structure you think is best for your business, you will in most cases need an attorney to draw up the appropriate contracts.
How to choose an attorney for your small business As with any type of advisor, you should carefully research your choices by asking business associates or other advisors you trust. Make sure you review their credentials and how much experience they have.