How to Decide on the Legal Structure of Your Business

There are many reasons today for owner-managers of businesses to look at the legal structure of their firms. The changing tax laws and fluctuating availability of capital are just two situations which require alert mangers to review what legal structures best meet their needs.

Each form of business organization has its advantages and disadvantages. This Guide seeks to briefly identify them for the owner-manager who wants to know "what questions to ask" when seeking the proper professional advice.

If you were to make an analogy between starting a business and playing a card game, you might say, "The game is just for fun, but business is business." Well, you would be right. But let's consider some important similarities.

The game requires skill, strategy, planning and, most important, a thorough knowledge of the rules. Going into business requires strategy and planning. Most important, to be successful in business, you must understand the rules (or the laws) by which you must conduct your business. All planning and strategy must consider the multitude of local, state, and federal laws and business practices that govern the operation of the business.

Before you enter the complex arena of business and the myriad of laws which influence your freedom of choice and mobility of action, you must first choose the legal structure for your business that will best suit your needs and the needs of your particular business. In order to intelligently select the legal structure for your business you must ask yourself, "What are my alternatives?" So, let's now look at the nature of various legal business structures.

There are three principal kinds of business structures: the proprietorship, the partnership, and the corporation. Each has certain general advantages and disadvantages, but they must all be weighted to reflect your specific circumstances, goals and needs. The sole proprietorship is the first firm we'll consider.

The Sole Proprietorship

The sole proprietorship is usually defined as a business which is owned and operated by one person. To establish a sole proprietorship, you need only obtain whatever licenses you need and begin operations. Hence, it is the most widespread form of small business organization.

Advantages of the Sole Proprietorship

Ease of formation. There is less formality and fewer legal restrictions associated with establishing a sole proprietorship. It needs little or no government approval and is usually less expensive than a partnership or corporation.

Sole ownership of profits. The proprietor is not required to share profits with anyone.

Control and decision making vested in one owner. There are no co-owners or partners to consult. (Except possibly your spouse.)

Flexibility. Management is able to respond quickly to business needs in the form of day to day management decisions as governed by various laws and good sense.

Relative freedom from government control and special taxation.

Disadvantages of the Sole Proprietor

Unlimited liability. The individual proprietor is responsible for the full amount of business debts which may exceed the proprietor's total investment. This liability extends to all the proprietor's assets, such as house and car. Additional problems of liability, such as physical loss or personal injury, may be lessened by obtaining proper insurance coverage.

Unstable business life. The enterprise may be crippled or terminated upon illness or death of the owner.

Less available capital, ordinarily, than in other types of business organizations.

Relative difficulty in obtaining long-term financing.

Relatively limited viewpoint and experience. This is more often the case with one owner than with several.

Note: a small business owner might very well select the sole proprietorship to begin with. Later, if the owner succeeds and feels the need, he or she can form a partnership or corporation.

The Partnership

The Uniform Partnership Act, adopted by many states, defines a partnership as "an association of two or more persons to carry on as co-owners of a business for profit." Though not specifically required by the Act, written Articles of Partnership are customarily executed. These articles outline the contribution by the partners into the business (whether financial, material or managerial) and generally delineate the roles of the partners in the business relationship. The following are example articles typically contained in partnership agreement:

Name, Purpose, Domicile

Duration of Agreement

Character of Partners (general or limited, active or silent)

Contributions by Partners (at inception, at later date)

Business Expenses (how handled)

Authority (individual partner authority in conduct of business)

Separate Debts

Books, Records, and Method of Accounting

Division of Profits and Losses

Draws or Salaries

Rights of Continuing Partner

Death of a Partner (dissolution and winding up)

Employee Management

Release of Debts

Sale of Partnership Interest

Arbitration

Additions, Alteration, or Modification of Partnership Agreement

Settlements of Disputes

Required and Prohibited Acts

Absence and Disability

Some of the characteristics that distinguish a partnership from other forms of business organization are the limited life of a partnership, unlimited liability of at least one partner, co-ownership of the assets, mutual agency, share of management, and share in partnership profits.

Kinds of Partners

Ostensible Partner. Active and known as a partner.

Active Partner. May or may not be ostensible as well.

Secret Partner. Active but not known or held out as a partner.

Dormant Partner. Inactive and not known or held out as a partner.

Silent Partner. Inactive (but may be known to be a partner).

Nominal Partner (Partner by Estoppel). Not a true partner in any sense, not being a party to the partnership agreement. However, a nominal partner holds him or herself out as a partner, or permits others to make such representation by the use of his/her name or otherwise. Therefore, a nominal partner is liable as if he or she were a partner to third persons who have given credit to the actual or supposed truth of such representation.

Subpartner. One who, not being a member of the partnership, contracts with one of the partners in reference to participation in the interest of such partner in the firm's business and profits.

Limited or Special Partner. Assuming compliance with the statutory formalities, the limited partner risks only his or her agreed investment in the business. As long as he or she does not participate in the management and control of the enterprise or is in the conduct of its business, the limited partner is generally not subject to the same liabilities as a general partner.

Finding the Money Needed to Starting a New Small Business. Now that You have calculated your first capital requirements, where are
you going to receive the money? The first source is the personal savings. Then relatives, friends, or other individuals might be
found who would like to"enterprise" their savings in your business. Before obtaining too big a share of money from outside
sources, remember that you ought to have private control of enough to assure yourself possession.

After you can show that you have closely worked out your financial Requirements and can demonstrate experience and ethics, a
financing institution may be willing to finance part of your working needs. This may be done on a short-term basis of from 60 days
to up to one year. Any institution which has money to lend is primarily concerned with security. The security might be a business
advantage, but if you are just starting the best security is usually your home or any other private asset.

The next thing that the lender will want to see is some sort of Business plan. If you finish a business plan - which includes a
cash flow forecast - that the lender will observe that you have done some serious and realistic thinking about your business and
be more likely to consider your request.

Become acquainted with your banker. In selecting a banker consider Progressiveness, mindset toward your company, credit services
offered, and also the dimensions and management policies of the lender. Is your bank progressive? The physical look of the lender
may provide you some indication. When the employees are pretty youthful, interested in your problems and active in civic affairs
the bank is likely to be progressive. The nature of the lender's advertisements may also be an indicator for its progressiveness.

To succeed the banker Ought to Be interested in Assisting You to Become a better manager, and develop a continuing relationship
that will mean rewarding business for you and the bank over the years.

Will the lender offer you the kind of credit you want? By Way of Example, If seasonal accumulations of inventory turned into an
issue will the bank create a loan against public or field warehouse receipts? If your capital is tied up in accounts receivable
during your hefty selling season, will the bank take these receivables as collateral for a loan? Will the lender consider a term
loan?

Finally, understand the dimensions and direction policies of the lender. Will Your maximum requirements fall well within the
bank's"legal limit"? If you plan to do some export company, does it have a currency department? In the event that you or your
traders sell on installment terms does the lender have facilities for managing installment paper? How deeply is the lender
concerned with the rise and prosperity of the local community?

When you deal with your banker, sell yourself. Whether or not you Need a bank loan, make it a practice to visit your banker at
least once every year. Openly discuss your strategies and problems. It's the bank's business to not betray a confidence. If you
need financial assistance carefully prepare, in written form, complete information that will present a thorough comprehension of
your entire proposition. Many business-people or potential small business operators destroy their chances of obtaining financial
help by neglecting to present their proposal correctly.

Trade creditor or gear manufacturer, Firms from which you Buy equipment or product may also furnish capital for you in the kind of
extended credit. Producers of store fixtures, cash registersindustrial machinery frequently have funding plans under which you
might purchase in an installment basis and pay out of future income. You need not pay for the goods simultaneously. If products
are for resale, then no security aside from repossession rights of the unsold goods is involved. But too extended a use of charge
may prove expensive. Usually cash discounts are quoted when a bill is paid within 10, 30, or 60 days. By way of example, a term of
sale quoted as"2-10; net 30 days" means a cash discount of two percent will be granted if the bill is paid within 10 days. If not
paid in 10 days, the whole amount is due in 30 days. If you do not take advantage of the cash discount, you are paying 2 percent
to use money for 20 days, or 36 percent per year. This is high interest. Prevent it.

One of the main causes of failures among businesses is Inadequate funding. Should you enter business, remember it is your
responsibility to provide, or obtain from others, sufficient money to supply a firm foundation for the enterprise.

Sharing Ownership With Others. Now that you have determined what Company to start and about how much capital will be required, you
might find it necessary to connect with one or more partners to launch the enterprise.

If you lack specific management or technical skills which are of Major importance to your preferred company a spouse with these
abilities may prove a most satisfactory means to pay the deficiency. If you're extremely proficient in your particular area but
lack direction training and abilities, you may search for a partner with a background in management. If you might want more
startup money, sharing the ownership of this company is 1 way to get it. Great care should be taken in deciding upon a spouse.
Personality and character, as well as ability to render financial or technical assistance, affect the success of a pa333ship.

A partnership may be a mixed blessing. A spouse who puts in time Or money has a right to expect a share in running the enterprise.

In a partnership the liability for the debts of the firm is Unlimited, just as it is in one proprietorship. This means the owners
are Personally responsible for the company's debts, even in excess of the amount they Have invested in the organization. In a
corporation the accountability of the owner is Limited To the amount they pay for their shares of stock. A partnership, like a
single proprietorship, lacks continuity. This means the business terminates upon the Death of the owner or a spouse, or upon the
withdrawal of a partner.