So, you are thinking of starting a small business? You have gone over the fine details about what you are going to do to make money and how you are going to do it, but have you thought about the legal aspects of running your business?
There are generally three types of businesses: sole proprietorships, partnerships, and corporations. A sole proprietorship is an unincorporated business, not registered with the state, that is owned by one person. It is the easiest to organize because you do not have to go through the process of incorporating. The owner has complete control and receives all of the income that the business generates. A sole proprietorship, however, has its drawbacks, the most significant of which is that the owner is subject to unlimited personal liability. This means that if the business has debt, makes errors, or loses a lawsuit, the owner’s personal assets such as his or her house or car may be taken to pay for the debt, errors or judgment. General liability insurance can help to offset the risk of personal liability, but only up to the policy limits. In addition, there are substantial tax disadvantages of operating a business as a sole proprietorship, including income being subject to FICA tax and certain expenses which cannot be deducted.
A partnership is an unincorporated business organization in which multiple individuals, called general partners, manage the business and are equally liable for its debts. Other individuals called limited partners may invest in the partnership but are not directly involved in management and are liable only to the extent of their investments. Partnerships are somewhat easier to organize than a corporation, but a partnership agreement should be prepared and executed by all of the partners. Each of the partners is entitled to his share of any income from the partnership. As with a sole proprietorship, general partners are subject to unlimited personal liability for the partnership debt and also the actions of the other partners. Additionally, if the partnership agreement is not carefully drafted and there is a disagreement among the partners, significant problems can arise which threaten the continued existence of the partnership. In addition, there are tax disadvantages of operating a business as a partnership similar to those of a sole proprietorship. It should be noted that there are several different forms of partnerships. So, if you are thinking of a partnership, you also need to decide which type of partnership is best for your business.
A corporation is a formally registered entity having rights and liabilities separate from those of the individuals running the corporation. Incorporating is the formal process of filing articles of incorporation with the Pennsylvania Department of State. The corporate bylaws, or official rules and regulations which govern a corporation’s management, are also prepared. Based on the bylaws, a corporation is run by three classes of individuals: shareholders, directors and officers. Shareholders own shares of stock in the corporation which may entitle them to dividends and the right to vote on certain company matters, including the election of the directors. Directors are elected by the shareholders to oversee the management of the corporation. Officers are elected by the directors to oversee the day-to-day operations of the corporation. A corporation can be formed and operated by one person who can be the sole shareholder, director and officer.
Perhaps the most significant reason for incorporating is to limit your personal liability. Generally, shareholders, directors and officers are not liable for the debts, errors and judgments of the corporation. If you’re starting a business in such high-liability industries as food service, construction, child care and the like, the decision to incorporate is relatively clear. Even in less obvious circumstances, limits on your personal liability can be important, particularly if customers will be visiting your place of business. There may also be significant income tax savings for those who incorporate.
There are some drawbacks to incorporating, such as more paperwork and certain formalities and restrictions that accompany the fact that the corporation is a separate, legal entity from you. This separateness must be maintained, particularly by being careful not to co-mingle corporate and personal funds, having annual shareholder and director meetings, and signing documents in the corporate name.
If you believe that incorporating is not right for your business, then at the very least you should acquire an adequate general liability insurance policy and where applicable, register for a fictitious name for your business. Insurance policy limits will vary depending on your type of business and clientele. A fictitious name is any assumed name other than the proper name of the individual. The penalty for failing to register a fictitious name is that you may not use the courts of Pennsylvania to enforce a contract entered into using the fictitious name.
If you are considering starting a business or need help with an existing business, you may want to contact a Pennsylvania small-business attorney via email or call us at 724-837-0080 in Greensburg or toll free at 888-534-6016 for more information.