Understanding the risks: While conducting one's own business is attractive, many fail to appreciate the risks associated with operating a business. Any business may cause harm to others by acting unsafely or by failing to perform properly and fully the obligations undertaken with customers and others. A bad transaction may have consequences far beyond the scope of the transaction: failure to deliver $1,000 of widgets may cause far more than $1,000 harm to the party expecting the widgets. Some risks can be addressed with insurance, such as accidentally causing bodily injury, while others usually cannot, such as damage resulting from failure to perform a contract or from improperly performing a contract.
Conducing a business according to one of various forms of business organization may help ameliorate adverse consequences. As indicated below, choosing a form of business organization involves many considerations.
A first item to realize is that any person(s) conducting business in Massachusetts has already chosen a form of business organization (even if not consciously).
The chosen form of business organization will define the relationships between the persons participating in the business and and between the business and those with whom it interacts (customers, suppliers, lenders, sometimes by-standers, etc.).
The most common form of business organization are outlined below:
Sole Proprietorship: A sole proprietor is the sole owner of a business. The owner reaps all the benefits and assumes all the risks. If in the course of conducting business activities others are harmed (e.g., by improper performance of a contract, harm to person or property from carelessness or error), all of the owner’s property, not just business property, is at risk to compensate those harmed. Any such liabilities cannot be avoided by discontinuing the business. A sole proprietorship may have lenders but rarely has investors.
General Partnership: A general partnership is essentially a sole proprietorship among multiple owners. Worse than the risks associated with a sole proprietorship, each partner of a general partnership is responsible for the entirety of the obligations and liabilities of the partnership--including obligations and liabilities resulting from the conduct of other partners. If you are in business with others and have not formally formed a business entity, your business is in all likelihood a general partnership. Partners may more formally define the relationship among them.
Limited Partnership: A limited partnership is variation of the general partnership and partners of a limited partnership may be general partners or limited partners. General partners manage and conduct the business. As in a general partnership, the general partners are responsible for business obligations and liabilities. The limited partners are investors but are without authority to shape business policy. Limited partners are not responsible for business obligations and liabilities. A limited partner may share in the business profits without assuming responsibility for business obligations and liabilities.
Assumed Name: Proprietors and partnerships doing business under a name other than the name(s) of the owner(s) must file a certificate with local authorities identifying the assumed business name and identifying the owners operating under that name (a "doing business as" (DBA) certificate).
Corporation: Legally, a corporation is an entity separate from the people who operate the corporation (the business). As a result, the corporation (it’s assets) is responsible for the obligations and liabilities of the business, and the property of those participating in the corporation is shielded from business obligations. Because a corporation is a separate entity, a corporation is separately taxed (a cost of operating in a preferred form of business). Small corporations can avoid this separate tax treatment.
In summary, a corporation is owned by its shareholders, the shareholders elect directors, and the directors appoint|hire officers. The directors set policy and the officers run the day-to-day operations. A shareholder may purchase shares of the corporation and share in its profits without rising his or her assets to corporate obligations and liabilities: the only property at risk is the value paid for the shares. Corporations were originally created to encourage investment in business, permitting investors to share in profits without risking their entire assets to satisfy business obligations and liabilities.
Limited Liability Partnership and Professional Corporation: The limited liability partnership and professional corporation were developed to address the shortcomings of the general partnership. In a limited liability partnership|professional corporation, each partner or participant, while responsible for ordinary business obligations, are not responsible for losses caused by the conduct of others participating in the business (but remains responsible for losses caused from his or her own acts).
Limited Liability Company: A limited liability company possesses much of the benefits of a corporation but with less complexity than involved in the management of a corporation.
Considering the Alternatives: Anything more sophisticated than a sole proprietorship or general partnership requires compliance with formalities of organization and continued existence. Of course, tax treatment must be considered. So-called “continuity of existence” is another consideration. Less sophisticated forms of organization are said to terminate on the death or withdrawal of its participants, while more sophisticated forms may continue in existence perpetually. In general, a suitable form of organization may be customized to meet the unique needs of its participants.
A common misconception is that a person in business may avoid exposing his or her personal assets from risks associated with conducting business by using a corporate from of entity. Generally, however, a person is response for is or her own acts, so, for instance, injury caused to others by negligence or faulty performance of an obligation, if those acts are committed by the business operator (or his or her employees) will be chargeable to the operator, even if using a corporate from of organization. Similarly, credit transactions with a corporation ordinary must be personally guaranteed by the operators.
Once a form of organization is established, it is imperative that the operators adhere to the formalities, both with respect to satisfying government requirements and in interacting with others. A lapse may defeat all the benefits associated with the form of organization.
Please allow the Law Office of Richard M. Russell to assist you in selecting and organizing a proper from of business organization.