New Business Registration: Sole Proprietor/Partnerships Vs. LLCs

So…. You’ve gotten past the initial trepidation and you want to go into business for yourself. Outside of all the other things you must consider when starting a business; you must understand HOW you are going to conduct your business. There are many different entities that your state has created that allow you to do business with vastly different consequences. Here are just a few things to consider. Please keep in mind that I reference Michigan law because that is where I practice.

Sole proprietor, partnerships vs. Limited Liability Companies

Some businesses start out as sole proprietorships, partnerships, limited partnerships, etc. A partnership is very simple to form and involves very little formality. The mere act of conducting business for a profit between two or more persons will cause a partnership to arise under Michigan law. With regard to Name Protection, In order to protect the partnership’s name, a Certificate of Co-partnership should be filed in the county where the partnership is located. A partnership can do business under more than one name by filing a Certificate of Persons Conducting Business Under Assumed Name with the county where the partnership is located (aka “dba’s”). The failure to file a Certificate of Co-partnership will not terminate a partnership. An additional benefit to the Certificate of Co-partnership is that it discloses to the public the partners who have authority to bind the partnership. With regard to agreements, a partnership agreement is not required, but it is recommended. The partners should understand what their rights and responsibilities are relative to one another. Without a partnership agreement, the law assumes that all partners share equally and make decisions equally.

All of the aforementioned entities do not afford you any personal protection from liability if things go horribly wrong in your business venture. In some cases, this is not of much concern because many start-ups have very little in terms of assets and neither do the individual owners. However, most people with the courage to start their business usually have assets they want to protect from litigation or court judgments. The important thing to remember in the beginning is whether your customers believe they are doing business with you personally or whether they understand that they are doing business with a company that you happen to own. If they believe that they are doing business with you, and you have done nothing with regard to state filings and your money goes directly into your personal checking; your potential exposure to liability could be immense. This potential liability also applies to you when your partner promises a customer something neither of you can deliver. Personally, I cannot think of a worse situation.

The LLC achieves the advantage of limited liability like a corporation, yet the owner need not observe traditional corporate formalities.

The lesson here is to know that at the very least; your state affords you the opportunity to do business as a Limited Liability Company (LLC). An LLC is created by filing Articles of Organization, which are similar to Articles of Incorporation for a corporation. Attorneys and promoters may sign LLC Articles of Organization so that an LLC can be formed in the same way a corporation can be formed. Initially, a member of an LLC was required to sign Articles of Organization. An LLC can be organized to engage in any lawful purpose permitted for corporations or partnerships, and its duration is perpetual unless otherwise indicated in the Articles. The name is protected when the Articles of Organization are filed. The name must contain the words “limited liability company” or “L.L.C” or “L.C.” (with or without periods). The LLC may adopt one or more assumed names by filing a Certificate of Assumed Name with the Department of Labor & Economic Growth. An LLC should provide for the rights and responsibilities of the members in an Operating Agreement. The lack of an agreement can be disastrous. Without an agreement, each member is entitled to one vote and the profits of the company are split evenly, regardless of what the parties intended. One or more members are allowed. This is a very important advantage for sole proprietors. A sole proprietor can become a single member LLC and will still be taxed as a sole proprietorship. The single member LLC need not be taxed as a corporation. This allows those persons who conduct a business as a sole proprietorship to obtain the benefit of limited liability with little expense or hassle. The LLC achieves the advantage of limited liability like a corporation, yet the owner need not observe traditional corporate formalities. The primary formality is that the owner must keep LLC funds in separate accounts and make certain the business is done in the name of the LLC; otherwise, the benefit of limited liability may be lost.

Under the Check-the-Box regulations by the IRS (absent an election otherwise), a single-member LLC is disregarded as an entity separate from its owners (thus referred to as a “Disregarded Entity;”“DE” herein) A DE is a tax-nothing. It is not taxed; its owner is taxed as if the DE did not exist. The corporation holding the DE functionally holds the LLC the way a corporation holds a wholly owned subsidiary corporation, which protects the corporate owner from the LLC’s liabilities. Single-member LLCs, treated as DEs for tax purposes, are very beneficial since a corporate owner does not need to file separate federal tax returns, yet achieves diversification of risk. The Articles of Organization must state the name of the LLC. The Articles must state the purpose of the LLC or that the LLC may engage in any activity for which an LLC may be formed under Michigan law. The Articles must also state the resident agent and office, the LLC’s maximum duration if it is not perpetual, and an indication of whether the LLC is manager-managed or member-managed.

These are but two options to consider when starting your new business venture. The next time we will navigate the vast differences between LLC’s and Corporations.