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CHOOSING THE LEGAL FORM
OF BUSINESS
The decision of the legal form
of business will be made to best suit your needs, personal management
style, and financing requirements. The original form you choose may only be
temporary. As the business grows and expands, you may find the need to
change legal forms. This is a very important decision with serious tax and
legal implications. If you are unsure about this decision you should
consult an attorney and/or an accountant. The most common forms of business
ownership are sole proprietorship, general partnership, limited
partnership, corporation (both regular and " S "), and statutory
close corporation. Another form of organization, the limited liability
company was passed by the South Carolina Legislature in June of 1994.
1. Sole Proprietorship
A sole proprietorship is
limited to a single owner (or owner and spouse), who has total control of
and responsibility for the business. Further, the sole owner must
contribute or borrow all of the capital needed to start the business. Any
outside funding sources must be in the form of loans. The sole
proprietorship is the simplest business form to organize and is the least
regulated. The profit or loss of the business is taxed as personal income
and is included on the owner's individual tax return. The sole proprietor
has full legal liability for debts and claims against the business.
ADVANTAGES
1. Easy to organize and
flexible
2. Owner has control and
responsibility
3. Minimum legal restrictions
4. Income taxed as personal
income
5. Minimal organizing costs
DISADVANTAGES
1. Owner is personally liable
for debts or claims
2. Business terminates with
the owner
3. Limited ability to raise
capital
2. Partnership
A partnership is a voluntary
association of two or more persons acting as co-owners of the business.
This form of business combines assets and talents of the partners to
conduct the business operations. Each partner can act as an agent for the
partnership through business operations, incurring debt, etc. The partners'
personal assets are at risk for all claims and debts of the partnership.
Although a partnership is
relatively easy to set up, a Partnership Agreement should be prepared by an
attorney to establish the rights and duties of the individual partners.
Because a partnership generally terminates when any partner dies or
withdraws or when a new partner is admitted, the partnership agreement also
describes how the termination will be handled.
ADVANTAGES:
1. Simple to organize
2. Combined funding and
talents of partners
3. Flexibility in profit or
loss sharing
4. Income taxed as personal
income
DISADVANTAGES
1. Unlimited legal liability
for all partnership debts and claims
2. Partnership terminates upon
death, withdrawal, or addition of partner
3. Individual partners act as
agents for the partnership
A limited partnership is a special
form of partnership that is not usually used for small businesses. A
limited partnership is owned by limited partners and at least one general
partner. The liability of the limited partners for claims and debts against
the partnership is fixed at the amount they have invested in the
partnership. The personal assets of the limited partners are not at risk.
In return, limited partners can have NO input in the day-to-day operations
of the business. Because a limited partnership is regulated by securities
laws, formation can be complicated and requires an attorney and an
accountant.
3. Corporation
A corporation is a separate
legal entity that is formed by filing Articles of Incorporation with the
Secretary of State in Columbia, South
Carolina. The owners of a corporation are
known as stockholders. Each owner invests money or other assets in the new
business in return for shares of stock at a predetermined price. The
stockholders are at risk only for the amount of money they have invested in
the stock of the corporation. The personal assets of the stockholders are
not at risk. Because corporations are considered legal entities (or
"artificial persons"), the corporation files income tax returns
and pays taxes. The corporation may also sue and be sued.
Under South
Carolina law, an attorney is required to sign
and file the Articles of Incorporation. Usually the attorney is assisted by
an accountant in organizing the corporation. Because of this, incorporation
can be both costly and complicated.
A Subchapter S (or
"S") corporation is a special form of a regular corporation. It
is incorporated as a regular (or "C") corporation, but asks for
special permission from the Internal Revenue Service to be taxed as a
partnership. In other words, a C corporation and an S corporation are the
same legally - they are organized in the same way and have the same legal
characteristics. But an S corporation does not pay income taxes. It simply
files an information return and the income or loss "flows
through" to the shareholders where it is taxed as personal income.
ADVANTAGES:
1. Limited liability for
managers and stockholders
2. Ownership is transferable
3. Corporation does not
terminate when ownership changes
4. May choose a fiscal year
end other than December 31 ("C" corp. only)
5. "S" Corporation
income or loss is passed through to stockholders and taxed at the
individual level.
DISADVANTAGES:
1. Costly and complicated to
establish
2. Double taxation for regular
corporations
3. Extensive record keeping
necessary
4. One class of stock for
"S" corporations
4. Statutory Close
Corporation
The statutory close
corporation is relatively new to South
Carolina (adopted in 1988), and is most
beneficial to businesses with 1-2 owners. The statutory close corporation
is usually a small, closely held corporation, professional corporation, or
wholly-owned subsidiary corporation. The statute allows the corporation to
do away with bylaws, board of directors, and annual shareholder meetings,
but requires a shareholder management agreement and perhaps other operating
agreements. Basically, the statutory close corporation allows the
elimination of some of the paperwork requirements that are burdensome to
the smaller business. However, since the requirements are reduced, it is
imperative that all the remaining requirements outlined in the Articles of
Incorporation be followed, in order to maintain the liability protection
afforded the business owner under the corporate form.
5. Limited Liability
Company
An LLC is a cross between a
partnership and a corporation. It provides for investors, simply called
"members" to contribute money or other consideration to the
company. These members share in profits and losses and can participate in
its management. Generally, each member has one vote, and members decide
most matters by a majority vote.
The LLC is created by two
documents, "articles of organization" and "operating
agreement". The articles of organization are similar to corporate
articles of incorporation and must be prepared and signed by the
"organizers" of the LLC. The articles of organization must be
approved by and filed with the Secretary of State. The LLC must have a
registered office and a registered agent. The registered agent is the
person who receives legal documents required to be served on LLCs. The
registered agent should be either an individual or a corporation.
The operating agreement is the
governing instrument of the LLC and must be adopted by all members. It can
contain any provision not inconsistent with law. The operating agreement is
similar to the by-laws of a corporation. Generally, the operating agreement
should contain provisions related to the conduct of the business and
affairs of the LLC, including the rights and powers of the LLC, its
members, managers, agents, and/or employees.
An LLC is considered a
separate person and as such is entitled to own property. As a person, the
LLC can sue and be sued.
ADVANTAGES:
1. Limited liability for members
2. Acquisition of capital
3. Potential for single taxation status as a partnership
4. No membership requirements
5. Not limited to one class member
6. Unlimited number of members
7. Less administrative burden than a corporation
DISADVANTAGES:
1. Complexity of organizing and operating
2. Sharing control and earnings
3. Uncertainty of legal issues
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