Dispelling Business Formation Myths
The pandemic changed a lot of things for a lot of people, but incredibly it led to a surge in new business formations, which spiked up 42 percent from pre-pandemic levels. Owning your own business and being your own boss is part and parcel of the American dream. But as with every life-changing move you make in life, the old motto “look before you leap” is particularly relevant to going into business, either by yourself or with others.
Businesses can take many forms from a sole proprietorship to a partnership to a Limited Liability Company (LLC) to a corporation. Each form has its unique advantages and characteristics, but one factor stands out for the entrepreneur going into business: liability—who or what is responsible for debts and legal judgments?
A sole proprietorship leaves the owner solely responsible for all obligations. A partnership shares the liability among the partners unless it is a limited partnership, in which the general partner assumes most liability. LLCs and corporations generally shield the initial investors from liability assumed by or thrust upon the operating entity. No matter your business goals, it’s always best to have reliable legal counsel in your corner.
If you are looking to form a business by yourself or with others in or around Overland Park, Kansas, or in Kansas City, Missouri or anywhere in Johnson County or Jackson County, turn to the Coppaken Law Firm. Our legal team will guide you in weighing all your options and choosing the right business format for your enterprise. If you’re already involved in a business and have questions or concerns about whether you’ve chosen the right format, reach out and we will review your business operations with an eye to mitigating and managing risk.
Common Misconceptions About Business Formation
Through the years in our work consulting with entrepreneurs looking to open a business, we have encountered several common misconceptions about the different structures available and what they mean for those entering the business world. Here are some of those misconceptions:
“Choosing a Business Format Is Important Only for Large Businesses.”
While a sole proprietorship is certainly a viable business format – think “Mom and Pop” – it carries with it a lot of risk. Every debt and every claim against the business becomes the owner’s responsibility. If debts outweigh revenue, the owner either has to make up the difference, sell the business and pay the debts (if possible), or seek bankruptcy protection. So, business formats do matter whether you’re Mom or Pop or a group of entrepreneurs. To mitigate your risk, you should look to form an LLC or a corporation.
“Incorporation Provides Absolute Liability Protection.”
While it’s true that a corporation, whether a traditional one or a Subchapter S corporation, largely shields the shareholders from debt and legal obligations, it is still possible for others to “pierce the corporate veil,” which means to expose the corporate structure as a sham set up so that the initial shareholders can drain assets from the company, even if they have been obtained through loans or sales of shares.
“You Won’t Have to Pay Taxes if You Form an LLC in Another State.”
Profits from an LLC flow to its members (the name for the owners), and they must pay taxes in the state where they reside. If investors form an LLC in Nevada to do business in California, however, the Golden State will still require that income earned in that state be taxed, so the members will be liable for those taxes. There could also be sales and use taxes, franchise taxes, and excise and transfer taxes. Plus, operating as a “foreign” LLC will require additional registration fees.
“LLCs Can Issue Shares to Raise Cash.”
LLCs cannot issue stock as a corporation can. The members of the LLC are the ones who must put up the money to launch the business and to make up for any shortfalls while operating the entity. That being said, an LLC has administrative benefits over corporations. LLCs are easier to launch, and they do not require the annual recordkeeping and stockholder meeting demands of a corporation. And they also provide personal liability protection as does a corporation.
“A Sole Proprietor Can’t Have Employees.”
The term “sole proprietor” refers only to how the business is owned. If Bill opens a hardware store, he can certainly hire employees to help him operate the business. The employees, however, will not be liable for any debts or legal obligations that the business chalks up. The sole proprietor will be on the hook.
“You Don’t Need an Attorney to Form a Business.”
If you’re a sole proprietor, you certainly can hang up a sign outside your store and register your DBA (doing business as), obtain any permits or license you need, and start operating. The emphasis is on “can.”
Though you technically can start a business by yourself or with others in any format, it is not the safest or surest path, especially when you don’t have a legal background. It’s in your best interest to seek counsel of an experienced business formation attorney.
A partnership requires a partnership agreement, and a corporation requires articles of incorporation. These are vital documents that must be done precisely to protect everyone involved. Even an LLC or sole proprietorship needs to cover all the legal angles before launching.
Get the Support of an Informed Attorney
If you’re in Overland Park, Kansas City, or anywhere in the counties of Jackson or Johnson, reach out to us at the Coppaken Law Firm with all your questions and concerns about starting a business, or about reviewing what you’ve started with an eye to minimizing risk and optimizing opportunity. Our business formation attorney can advise you of your best options that suit the enterprise you have in mind or that you’re creating.