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| Make Informed Choices... |
It’s
not easy to be a small business owner. There are many pitfalls that you often
can’t see until it’s too late. The good news is you don’t have to fall victim
to these difficulties. If you’re proactive in preventing some of the most
common problems, your business could easily sidestep potential disasters.
Over
the years, I’ve seen plenty of visionaries form small businesses without
considering protective measures. They select a business entity without
understanding that their choice affects: (1) their exposure ( or non-exposure)
to claims of third parties; (2) their ability (or lack of ability) to control
the management of their company; and (3) the operational costs and tax amount
that their company will pay.
In this blog, I will discuss the
perils of choosing the wrong business entity and the benefits of making an
informed selection, so your company can thrive without risk. The bottom line is
that while there are a number of business entities from which you can choose,
it is important for you to be aware of the distinct advantages and disadvantages
of each entity. For most businesses, the entity choice will be a corporation.
Choosing Your
Business Entity
But, before I get ahead of myself, let me first explain the
different business entities. They include:
* Sole Proprietor
* Partnership
* Corporation
LLC
The LLC is a popular choice that
is often recommended by accountants. It is essentially a blend of a corporation
and a partnership. Its benefits are that it provides the liability protection
(i.e. “corporate shield”) of a corporation and the tax benefits of a
partnership. But its disadvantages are significant and outweigh the benefits.
To start, LLCs have only been in
existence for about 40 years, which means that there is a limited amount of
case law to which a court can refer when dealing with LLC disputes with third
parties or among its own member-owners. This means that determining how a court
will enforce the rights of the LLC and its members is unpredictable. Secondly,
LLCs are expensive to create (the legal cost to create proper organizational and
management documents can exceed $2,000, plus a $750 filing fee) and costly to
maintain ($300/year). In short, LLCs should be avoided unless you have complex
tax issues that your accountant can demonstrate are best served by using an
LLC.
Sole Proprietor/Partnership
Given the pros and cons of the
LLC entity, you might think the sole proprietor or partnership options fare
better. They do not, as these entities have imbedded problems as well. For
example, neither a sole proprietorship or a partnership provides protection
against third party claimants or creditors. Moreover, the 50/50 structure means
that each partner has 100% veto power. This means that neither party has the
right to make a unilateral decision, even if it’s in the best interest of the
business. Thus, neither the sole proprietorship or the partnership should be
considered a safe or practical choice for your business entity.
Corporation
This leaves us with the final
business entity: the corporation. In Illinois, corporations have existed for over
145 years, thereby providing a wealth of case law on which courts may rely when
enforcing the rights of the corporation and its shareholders, director,
officers and employees. This provides predictability in evaluating the rights
and liabilities of the corporation and its owners and eliminates the gray areas
otherwise experienced with LLCs.
Secondly, corporations are
relatively inexpensive to form (i.e. $400 legal fee to create corporate book,
minutes and resolutions plus a $275 filing fee), and very affordable to maintain ($100 annual filing fee).
By mindfully choosing your
business entity, you’ll be looking out for the long-term health of your
company. Then, when you move forward, you can do so with confidence and peace
of mind.
Next week, I will discuss the
mechanics of “moving forward,” and the myth known as the “business plan.”
Need More Help?
For over 20 years, our experienced
attorneys at DregerLaw have assisted
hundreds of business owners throughout Chicago and Northern Illinois. We can
help you as well. Call us at 312-322-0955. Or follow this link* so that we can
guide you on your legal rights as a small business owner.
* The use of the information on this form for communication with the firm
or any individual member of the firm does not establish an attorney-client
relationship.
