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CHOOSING THE LEGAL FORM OF BUSINESS
In addition to the information below, you may also find “Selecting the Legal Structure for Your Business,” an SBA document, useful in making your decision.
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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 Legislator 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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