GETTING ORGANIZED: FOUR COMMON BUSINESS STRUCTURES
A business may be operated under one of several available business structures. Choosing the right structure for your company is one of the most important decisions you will make because it impacts how the entity is taxed, an owner’s personal exposure to liability and the ability to raise investment capital or loans. It also affects the level of government oversight along with reporting and paperwork requirements. Maryland state law defines and regulates each type of business model making it important that the business know and understand the legal rules that apply.
The four most popular business structures in Maryland and nationwide are the Sole Proprietorship, General Partnership, Limited Liability Company (LLC) and the Corporation. There are other structures that are also available. Because the business must comply with governmental requirements, organizational imperatives and tax procedures, the best place for a new or growing company to evaluate and select its best business model is at the office of an experienced business law attorney.
THE SOLE PROPRIETORSHIP
The simplest and most common form of business structure is the sole proprietorship. This comprises one individual in business as the sole owner. There is no legal separation between the owner and the business, meaning that the proprietor is the business for legal purposes. A sole proprietor enjoys total control over the management, development, marketing, and daily functioning of the business. This model offers ease of operation, few regulations, less reporting, and an easy method of taxation.
With all of that apparent business simplicity, one might question why a small business owner would not choose to operate under a proprietorship. The answer is that there are critical disadvantages, including that the owner is personally liable for business debts. This means that the owner’s personal assets may be attached and seized to satisfy business debts that are reduced to a judgment. Notably, this applies to all kinds of debts including personal injury or wrongful death awards, which can sometimes be huge. It is also difficult for the sole proprietorship to grow because investors will generally not consider this structure for assistance.
A General Partnership consists of two or more persons operating a business together for profit. Each partner contributes money, expertise, working labor, or a combination thereof, to the company. Each partner shares in the profits, losses, and business debts according to his or her percentage of ownership. Partnerships are easy to form, they do not require many formalities, and there is generally simple taxation. Their informality makes this a viable choice in some cases where the partners want to first see whether the business concept will be successful.
The biggest drawback is that the partners are not given limited liability. Maryland, however, provides partnership models that do provide limited liability. The Limited Partnership (LP) is a more complex structure that usually has one general partner and several limited partners. The general partner has unlimited liability, whereas the limited partners risk only up to the amount of their investment. Limited partners do not usually join in the company’s management.
Maryland also provides for a Limited Liability Partnership (LLP), which provides limited liability to all of the partners. This structure is available for professional practices, such as lawyers, accountants and doctors who practice together.
THE LIMITED LIABILITY COMPANY (LLC)
An LLC combines features of both a partnership and a corporation. Unlike the sole proprietorship or the general partnership, the owner of an interest in an LLC, called a member, enjoys limited liability and is protected personally from the debts of the business. Additionally, the LLC offers “pass-through” taxation, fewer regulations and broad flexibility. The LLC, which has become popular in recent years, is governed by an operating agreement.
Flexibility of an LLC includes optional forms of taxation, various management models, and creation of hybrids that mix qualities of different business structures together. For example, the operating agreement can specify that the business will be run by a manager or it may be set up as a member-run organization. The LLC is disadvantaged in that it is not suitable for raising large amounts of venture capital or attracting investors for a public offering.
A corporation is owned by the shareholders, operated by the board of directors, and managed by the officers. It must have meetings and must follow strict procedures for taking corporate action. A corporation’s stock shares may be sold to the public if all of the considerable legal hurdles are satisfied. Most corporations, however, are privately owned. These smaller private companies usually have a shareholder agreement restricting share transfers to outsiders.
A corporation exists perpetually and enjoys limited liability for its shareholders. A smaller business can elect a special “S” status which simplifies taxation. Also, Maryland law provides for a “close corporation,” which is designed for smaller companies limited to a certain number of shareholders. This model has reduced formalities and may be set up without a board of directors. Maryland also allows certain non-stock corporations, usually for charitable and non-profit organizations.
A corporation is the choice of large companies that operate nationally and internationally, and that can attract large investors to finance rapid growth and a public offering. A disadvantage is that it suffers from an overabundance of paperwork and government regulations. It is the costliest structure to start and to maintain. The disadvantages, however, are accepted as a cost of business success.
In the final analysis, choosing a business structure here in Maryland is a complex process involving several competing factors. The personalities, aspirations, experiences and goals of the owners may color the ultimate choice of business structure. When a business structure has to be changed, the business attorney will guide you through the process. Sometimes, that is a cost of growing the business, which makes it a pleasant transformation more than an unwanted expense.
For guidance in selecting the appropriate structure for your business, contact Maryland business law attorney Elsa W. Smith at the Law Offices of Elsa W. Smith, LLC. We have two offices to serve you – Annapolis (410) 995-7719 and Laurel (301) 358-4340. You can also contact us through this website.