By: Thomas S. Tripodianos Published: February 2007

Choice of Entity: Organizing Your Business (Part 1)

In each issue of the BAHV Newsletter, Thomas S. Tripodianos, Esq. provides our members with answers to their commercial litigation, real estate and construction law questions.

William A. Brenner, CPA provides members with information on a variety of business management, profitability and tax topics, intended to increase member awareness and stimulate thought about issues that can greatly affect profitability, business growth and quality of life.

Both Tom and Bill have often given the advice that no one professional can properly satisfy all your needs. Rather, a "Management Team" should be assembled to address the multitude of issues facing your business. At a minimum your team should consist of an attorney, accountant, and insurance professional.

In this special joint installment of their columns Bill and Tom explore the pros and cons of the various organizational forms available to business owners.

Choice of Organizational Form

Choosing an organizational form that best suits the needs of a business and its participants is complicated. This article presents a cursory introduction to the legal and tax implications of the choice.

The Range of Organizational Choices

The organizational forms that they can be used to structure a for-profit business exist along a continuum. Each form can be manipulated to approximate the characteristics of the others. Keep in mind that whatever structure you choose, it will not significantly affect how you conduct your day to day business. The organizational form determines legal relationships, responsibilities for business debts, and tax liability.

The more common choices available to business owners are:

Sole proprietorship. A single individual owns the business assets and is liable for any business debts; Proprietorships usually are small, with few capital needs that cannot be met from the owner's resources and from lenders. There can’t be more than one owner of a sole proprietorship.

General partnership. If you arrange to operate the business with someone else, while sharing control and profits, you automatically create a partnership. As partners, you are each individually liable for all partnership debts. Partnerships are prevalent in service industries - such as law, accounting, and medicine - where trust must exist among the participants and capital needs are not great.

Limited partnership. You can form a limited partnership in which so-called limited partners provide capital and are liable only to the extent of their investment. General partners run the business and are fully liable for partnership debts. Since limited partners need not be general partners, one person or entity could be the general partner and both can be limited partners. Limited partnerships combine tax advantages and limited liability.

Limited liability Company. ("LLC") You could form a limited liability company - an entity that is a hybrid between a corporation and a partnership. Like a partnership, the members of an LLC provide capital and manage the business according to their operating agreement; their interests are not freely transferable. Like a corporation, members are not personally liable for debts of the LLC entity.

Corporation. You can form a legal entity called a corporation. Shareholders provide capital, and directors and officers manage the business. Unless there is fraud or inequity that justifies "piercing the corporate veil", corporate participants are not personally liable for corporate debts; only the corporation is liable. Corporations are the principal means of organizing businesses with complex organizational structures and large capital needs. The corporate form, however, works for any size business, including a one-person "incorporated proprietorship."

There are other variants. A joint venture is basically a partnership with a defined, closed-end objective. In a business trust, investors transfer property to a trustee who manages and controls the property for their benefit. The investors' beneficial interests are freely transferable, and the beneficiaries generally are not liable for trust debts. A professional corporation allows certain professionals - doctors, lawyers, and accountants - to obtain some advantages of incorporation without running afoul of ethical rules that prohibit professionals from limiting their liability through use of the traditional corporate form.

Choosing between a Partnership and a Corporation

If you want to share in the control and profits of the business, you would likely choose between a partnership, limited liability company, or a corporation. Although a business planner can adapt each form to suit particular needs, some characteristics are relatively immutable - formation, liability, and tax. Others require planning - duration, management, and transfer of ownership interests.

Life Span - Formation and Duration

General Partnership. A general partnership is created any time two or more persons associate to carry on a business as co-owners to share profits and control. It requires no legal documentation. Unless agreed otherwise, a general partnership dissolves upon the death, bankruptcy, or withdrawal of any partner. Without planning, there is no assurance that a partner will not withdraw and demand that the business be liquidated.

Limited Partnership. A limited partnership arises when a certificate is filed with a state official. A limited partnership lasts as long as the parties agree or, absent agreement, until a general partner withdraws.

Limited Liability Company. An LLC arises when two members file articles of organization with a state official. Unless otherwise provided for by agreement, an LLC dissolves upon the death or withdrawal of any member.

Corporation. A corporation arises when articles of incorporation are filed with a state official. Corporate existence is perpetual, regardless of what happens to shareholders, directors, or officers.

Management -Authority to Bind and Control the Business

General Partnership. Each partner is an agent of all other partners and can legally bind the partnership, either by transacting business as agreed by the partners (actual authority) or by appearing in the eyes of third parties to carry on partnership business (apparent authority). Unless otherwise agreed, a majority vote of the partners decides ordinary partnership matters, but anything that is extraordinary or contravenes the agreement requires unanimity.

Limited Partnership. General partners have authority to legally bind the partnership as to ordinary matters. Limited partners have voting authority over specified matters.

Limited Liability Company. Most LLC statutes give broad authority to bind the LLC in much the same way as partners. Management of the LLC business is decided in proportion to the members' capital contributions, unless the members agree to centralize decision-making by electing managers.

Corporation. The corporation has a centralized management structure. Its business is under the management and supervision of the board of directors. Officers carry out the policies formulated by the board. Shareholders elect the board and decide specified fundamental matters; they cannot bind the corporation.

Transfer of Ownership Interests-Free or Restricted

General Partnership. A partner cannot transfer his or her interest in the partnership unless all of the remaining partners agree, or the partnership agreement permits it.

Limited Partnership. A general partner cannot transfer its interest unless all of the other general and limited partners agree, or the partnership agreement permits it. Limited partner interests are freely assignable.

Limited Liability Company. An LLC member cannot transfer her LLC interest unless all of the other members consent. Some LLC statutes suggest that under specified circumstances, the articles of organization can provide standing consent to new members.

Corporation. Corporate shares are freely transferable unless there are specific written restrictions.

Liability - Unlimited or Limited

General Partnership. Partners have unlimited liability. Their personal assets are at risk for all partnership obligations, whether they are contractual or arise because of misconduct (torts) of the partners or partnership employees.

Limited Partnership. At least one partner must be a general partner, with unlimited liability. Limited partners are liable only to the extent of their investment, so long as they do not "participate in the control" of the business. Older statutes did not define "participation," and courts construed the term broadly. Limited partners were said to participate in control if they shared in operational decisions, retained control of financial matters, and decided the general partner's tenure. Modern statutes clarify that some activities do not constitute participation in control. Limited partners do not lose their limited liability merely by being officers, directors, or shareholders of a corporate general partner, voting on major business matters, or advising the general partner.

Limited Liability Company. In both their capacities as capital contributors and managers, LLC members are not liable for LLC obligations beyond their investment. Some statutes, however, state that LLC members can become liable for LLC obligations by reason of their own acts.

Corporation. Shareholders have limited liability for corporate obligations. This is true also for directors and officers acting on behalf of the corporation. Corporate participants can lose only what they have invested unless there is fraud or an inequity that justifies "piercing the corporate veil." Often, large creditors of small corporations will demand that corporate participants personally guarantee the corporation's obligations, thus reducing the significance of corporate limited liability.

With any of these entities, if a partner, member of shareholder personally guarantees debt of the entity, he or she will be liable for that debt if the entity is unable to comply with its repayment terms.

If you would like more information regarding this topic, please contact Thomas S. Tripodianos at TTripodianos@wbgllp.com, or by phone at 845-294-5500 x 317. Bill Brenner can be reached at , or by phone at 914-949-2990 x 313.

Please understand that this column provides general information only, and should not be construed as legal or tax advice to anyone under any circumstances. While we encourage you to contact us, you should not disclose to us any information that you consider confidential unless and until we have formally established an attorney-client or accountant-client relationship, and agreed to represent you in your particular matter. The opinions expressed in this column are of the individual authors, and not necessarily those of the Builder’s Association of the Hudson Valley.

Thomas S. Tripodianos is a partner at the law firm of Welby, Brady & Greenblatt, LLP. Welby, Brady & Greenblatt, LLP emphasizes the practice of Construction Law, representing general contractors, subcontractors, sureties, developers, owners, suppliers, engineers, homeowners and other entities connected with the construction industry in transactions, litigation, arbitration, mediation, public and private construction contracts, mechanic's liens, surety law and environmental law. Welby, Brady & Greenblatt, LLP has its principal office in White Plains, New York, and also has offices in New Jersey and Connecticut. Mr. Tripodianos resides in Orange County.

Bill Brenner is a manager at the accounting and consulting firm of Citrin Cooperman & Company, LLP. Ranked among the top 40 accounting firms in the U.S., Citrin Cooperman provides business consulting, tax and accounting services to business owners in the Tri-state area and Hudson Valley. The Firm has offices in White Plains, mid-town Manhattan, and Springfield, New Jersey.

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