Picking what kind of business you’re going to be – “choice of entity” – is one of the first and most important things you do when you start a business. It’s an area where many business owners can get into trouble because they don’t know what they don’t know. Beyond basic issues of personal liability and how many people are in your company, there are subtleties you may miss if you don’t know the law.
Here are some common business types, and why they may be the wrong choice for your business. (If you think you’ve already set up your business as the wrong entity, don’t worry; Gem and his associates can help you.)
Sole proprietors and partnerships
The benefits of sole proprietorship and partnerships
Many businesses default to these business types because they don’t require any formal federal or state paperwork to set up. (You should still look into whether you need licenses and permits, though.) If you start selling baby blankets online and making money, you’re automatically a sole proprietor. If you and your buddies start roasting coffee and selling it, you’re in a partnership. It’s very easy, which is why these are still very common business structures.
What to watch out for
The major drawback – and it’s a big one – of being one of these two types of business entity is that you have no liability protection. Your personal assets are not protected in case your business is sued or goes into debt. That means that you can lose your money, your home, your car, and any other assets you have if the business gets into trouble. For partnerships, you take even more risk, because you’re not just reliable for your own actions and debts you incur, you’re liable for those of your partners, too.
The bottom line
It’s better to choose a different business structure altogether than to accept the risk of putting your personal assets on the line.
Limited liability companies (LLCs)
The benefits of LLCs
The big benefit is liability protection. With an LLC, as long as you maintain a separation between business and personal accounts, you will be (in most cases) protected from being held personally liable for the debts of your business. An LLC is flexible because you can have a single-person LLC or an LLC with multiple people. For taxes, the income (or loss) “passes through” to the owners to include on their personal tax returns.
For all these reasons, the LLC is an ideal business structure for many companies.
What to watch out for
With LLCs, there’s more than meets the eye. Did you know that there are four ways to establish a limited liability company in South Carolina? Most people don’t. And when most people set up the business themselves, they inadvertently set it up as the wrong type of LLC.
An LLC can either be “term” or “at will” and can be “member managed” or “manager managed.” Let’s say you and your friend are in an LLC together and you don’t yet have a buy-sell agreement. If your friend dies, and your LLC is set up as “at will” instead of “term,” you have only a limited time to buy out their portion of the business, or the business dissolves.
Or let’s say you’re in an LLC with your business partner and your LLC is set up as “member managed.” Even if that person owns just 1% of the business, they can go to the bank and take out money in your company’s name, which you’re now on the hook for.
The bottom line
The LLC is a great business structure, but you need to make sure it’s set up as the correct type of LLC. There are four possible types of LLC, and only one is ideal.
Corporations
The benefits of corporations
As a business entity, the corporation is great because it’s robust and can grow easily with capital from investors. Most of the brand name companies you know are corporations. You can choose to be a C-Corp or an S-Corp depending on how you want to be taxed. This is a great choice for a company looking to grow with outside investors and shareholders.
What to watch out for
If you’re a regular corporation, you’ll be required to have a board of directors, hold regular meetings, keep meeting minutes, and have those minutes available to shareholders to review. Failure to do these things can lead to a Plaintiff’s lawyer asking a court to “pierce the corporate veil” when the company is sued. That is, blurring the line between what’s business and what’s personal. In the worst-case scenario, you could be personally liable and find yourself paying off the company’s debts with your own assets.
But you can sidestep these problems entirely by electing to become a “statutory close corporation” by filing with the State of South Carolina. Every corporation in South Carolina is eligible. You get the benefits of being a corporation, but you won’t be required to have a board of directors and hold meetings if you don’t want to.
The bottom line
If you’re already a corporation but your company is not meticulous about holding board meetings and maintaining minutes, look into becoming a statutory close corporation. And even if you are meticulous, it’s just one more layer of protection for you.
Get Help Setting Up Your Business
The majority of companies are not set up in a way that’s optimal for the business owner, says Mount Pleasant business attorney Gem McDowell. If you want to discuss choice of entity for a new or existing business, call Gem and his associates at (843) 284-1021 today. They can help you evaluate your options and choose the entity that’s right for your business.
