Small Business Primer – Part 2: What Type of Business Will You Run?

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The last article illustrated how you can identify the kind of business you’d like to be in. Today, let’s look at the legalities of your new venture…

You received your very first pink slip today. The company you worked for was forced to lay-off 500 employees due to the current economic situation, and someone up above decided that you’d be one of the “lucky” 500.

But rather than feel sorry for yourself, you’ve decided to start building your on-the-side freelancing business into a full-time concern. So why not start up your own small business? Maybe you’re looking for something bigger — a partnership? Or a corporation, perhaps?

Grab your running shoes! Today I’ll take you for a jog down Business Setup Avenue. On the left, we’ll explore about the basics of becoming a sole proprietor, along with the advantages and disadvantages. Who knows, you could already be a sole-proprietor without even realizing it! And over there on the right, you’ll see the details of partnerships, how to get them rolling and what to avoid when setting them up. And straight ahead lies the corporation. You may not be ready to incorporate today, but you might in a few years. So why not learn all the ups and downs early?

Becoming A Sole Proprietor

Believe it or not, you might already be a sole-proprietor without knowing it! Are you a freelance Web designer? Do you do sub-contract your skills to a computer programming firm? Maybe you’re a salesman who only receives a 10% commission? Well, guess what? You’re a sole proprietor!

Of the three different business structures mentioned here, setting up as a sole-proprietor is by far the easiest. Very little paperwork is involved, if any. Messy contracts are out of the picture. And lawyers may not even be necessary (although they are, of course, highly recommended).

Depending on the state you’re in, you may be required to obtain special permits or licenses that will allow you to conduct your business. As long as the business doesn’t require any special professional or vocational licenses, such as a doctor or plumber’s might, business permits are relatively easy to pick up. For more information about state and local laws, check with your accountant or lawyer, or even make a call to City Hall. Your lawyer will also know where to buy your business permit, and can inform you of any other laws or ordinances that your business will have to follow.

There are several attractive advantages to being a sole-proprietor, while there are just as many disadvantages. So let’s address the key issues that you should consider before you start up your own sole proprietorship.

Due to the small amount of paperwork involved, and the minimal price of registration fees, becoming a sole-proprietor is a very simple undertaking. Because there is only one owner, that person has total control over most, if not all, business decisions. All company profits are paid directly to the owner, and aren’t split with other people, such as partners. If the owner were to die, the company would be quite easy to dissolve, as it would be given to the beneficiary of the will. Running a business this way allows the owner to control their work schedule, which often delivers greater flexibility than some other options, and this is what makes sole proprietorships so appealing to so many people. Compared to partnerships and corporations, a sole-proprietor doesn’t have anywhere near as many rules and regulations to worry about.

The owner is also responsible for all debts of the business, which does leave their personal assets at risk of repossession. And with only one contributing revenue source, it can be very difficult to raise the capital to run a successful business. Hiring a knowledgeable and dependable employee can prove to be a difficult task for a small business, particularly if they can’t afford to offer market wage or many opportunities for promotion. The owner is, of course, also responsible for taking care of all tasks, including simple jobs such as cleaning the toilet. And, due to the nature of operating a business, income can be very unstable at times. Not surprisingly, all the problems outlined here can lead to increased stress, and heighten the likelihood of the business owner sustaining stress related injuries.

Forming A Partnership

A partnership is when two or more people join forces, combining their strengths to start a business together. Partnerships require more legwork than sole proprietorships do, but can be worth the effort. The potential partners must meet with a lawyer, who’ll create a binding contract between them – and this contract is essential to a successful partnership.

The contract dictates what functions each partner will perform through their role in the business. It outlines the payment situation, as some partnerships do not split profits and expenses equally. The contract also states what will happen to the business if one partner dies or wants to leave, and indicates whether new members can be added to the partnership. And finally, the contract will also dictate the method of resolution for any disputes that may emerge among the partners in the course of running the business.

Like a sole proprietorship, a partnership can also be fairly simple to set up, even with the extra paperwork and lawyer involvement. Each of the partners receives a certain percentage or agreed upon amount of the companies profits. When several partners are involved, there will usually be many more revenue sources available for the procurement of starting capital. The special skills of each partner should complement each other, which in turn creates a stronger and more successful business. For the most part, the company profits will be shown on each partner’s personal tax return, so there’s no messing around with complicated tax forms. Partnerships often find it much easier to attract skilled employees than a sole-proprietorship would, as partnerships can offer employees the incentive of achieving their own partnership in the firm, which is particularly popular with lawyers and accountants. And, similar to a sole proprietorship, a partnership is much more flexible than a corporation in terms of rules and regulations.

As is also the case in a sole proprietorship, each partner is liable for the debt that the business accrues. Most business plans are establish with the agreement of all partners, which can also cause problems, as disagreements between partners can often occur. Not all employee benefits are tax deductible, and the partnership may have a limited life (as either partner may quit or die at an unknown time), unless the contract includes provisions for this situation.

A partnership is much less flexible than a sole proprietorship, but can suffer the same instability when it comes to income and cash flow. If the business’s partners don’t get along, or have complementary skills, they could again experience major problems. And if one partner doesn’t fulfill their part of the partnership agreement, the contract can be difficult for the other partner (or partners) to sever, even given specific clauses that may have been written into the contract for just such a situation. Stress is also common in partnerships, as not only do the partners have to worry about the business itself, but they must also nurture good working relationships with the other partners.

Incorporating a Business

A corporation is considered its own unique entity. It functions and has rights and privileges, somewhat like a person. A corporation can sue others in court, and be sued by others in court; can enter into, and be bound by, contracts. A corporation has the ability to borrow money from creditors, and even the government. Any corporation is required to hold a business license in its own name, and must pay taxes.

Incorporating a business also promotes the existence of a company. For example, recently the founder of the fast-food chain Wendy’s, Dave Thomas, died. As Wendy’s is a corporation, it will remain open and continue to grow (not to mention make delicious hamburgers). Had it been a partnership or sole proprietorship, it might have folded on the death of the founder.

Unlike partnerships and sole proprietorships, corporations face limited liability, which means that the owners (called shareholders) are not held financially responsible for the debts of the business. However, this does not mean that the shareholder is completely “off the hook”, so to speak. The shareholder is still responsible for the number of stocks they own, so in some cases, the shareholder could very well lose their whole investment if these funds are needed, for example, to pay creditors.

Corporations can also enjoy great tax advantages, but these will depend on where the corporation is located. Your local accountant or tax lawyer will have more information regarding this.

Additional funds and capital can be easily gained in a corporation, as shareholders can simply sell off additional stock, and this use of stocks to represent (to some degree) a person’s power within the business also allows company ownership to be easily transferred. Lastly, the corporation’s Board of Directors can contribute considerable knowledge in many areas, and this is usually extremely beneficial to the corporation’s overall success.

Corporations are much harder to set up than other types of businesses outlined here. Many government laws and regulations must be met, and because of this, a corporation usually requires more time and money than the other forms of business to set up. In some cases, instead of tax advantages, the business may actually face tax disadvantages through incorporation, and the business’s minority shareholders can be exploited if their knowledge and experience isn’t valued by majority stockholders.

Now that you’ve got the skinny on setting up the proper business, get out there and do it! Make the calls, meet the lawyers, complete the paperwork, and put your college education and experience to work.

Don’t miss the next article, where we’ll address the question of client relationship management . We’ll look at what’s involved — and what tools are available to make the job easier…

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