Each week, I have individuals who contact my office and want to discuss starting a new business. When starting a new business, the first decision which must be made is what type of entity will be established to operate the new business. The four types of entities used to operate a business are a sole proprietorship, a partnership, a limited liability company, or a corporation.
A sole proprietorship is a type of entity that is owned and operated by one individual and the business is the individual. The owner of the sole proprietorship receives the revenue and is responsible for the liabilities. An advantage of the sole proprietorship is that it is the simplest form of business ownership. A disadvantage of a sole proprietorship is that the owner has unlimited liability for the operations of the business.
A partnership is a business where two or more people are the owners. An advantage of a partnership is its simplicity for ownership when there is more than one individual who is the owner. A disadvantage of a partnership is that each individual partner has unlimited liability and can bind the other partners to liability for their actions relating to the business.
A limited liability company is another type of ownership of a business. This type of entity needs to be established with the Ohio Secretary of State and can have one or more owners who are referred to as members. The biggest advantage of a limited liability company is that owners can limit the number of their liabilities for the operations of the business to the amount of their investment in the business. In addition, members cannot obligate other members to personal liability for their actions in the operation of the business. The members are taxed on the profits and the limited liability company is not taxed at the company level.
A disadvantage of a limited liability company is the formality that must be followed when forming and operating the limited liability separate and apart from each of the individual member’s personal matters. For example, the limited liability company should have a separate checking account in which their revenues are received and expenses are paid. Plus, all contracts need to be in the name of the limited liability company and not in the names of the individual members.
A corporation is another type of business entity that can have one or more owners. The owners are referred to as shareholders. The shareholders elect directors who make major decisions for the corporation including the election of the officers. Normally the officers are a president, vice president, treasurer, and secretary. These officers run the day-to-day operations of the corporation. This type of entity is required to be established with the Ohio Secretary of State.
The biggest advantage of a corporation is that the liabilities of the shareholders for business operations are limited to their initial investment and any other future contributions they make to the corporation. Individual actions of shareholders cannot bind the other shareholders. Another potential advantage of a corporation is that a corporation that elects to be taxed as an S-corporation can have all of the net profits taxed at the shareholder level only and not the corporate level also. However, a C-corporation is taxed at both the corporate level, and then when dividends are issued to the shareholders, the shareholders are also taxed at their individual level.
A disadvantage of a corporation is that it is required to follow specific formalities when establishing and operating the corporation. For example, annual shareholder and director meetings need to be held and minutes are taken from those meetings. Also, the corporation needs to have a separate checking account in which revenues are deposited and expenses are paid. Plus, all contracts need to be in the name of the corporation and not the names of the individual shareholders.
Before establishing a new business, contact your attorney and accountant to determine the type of entity that should be selected to operate the business.
NOTE: This general summary of the law should not be used to solve individual problems since slight changes in the fact situation may require a material variance in the applicable legal advice.
James F. Contini II, Esq.
Certified Specialist in Estate Planning, Trust & Probate Law by the OSBA
Krugliak, Wilkins, Griffiths & Dougherty Co., LPA
158 North Broadway New Philadelphia, Ohio 44663