Business FAQ
Q: What are some of the more important issues that people face when going into business for themselves
A: Successfully operating your own business requires an understanding of the risks involved. Most small businesses do not succeed in the long run. Some of the reasons for failure include:
- Lack of a business plan that thoroughly addresses all of the "what if's"
- Maintaining a “top heavy” organization
- Not understanding the business or the business marketplace
- Lack of capitalization and underestimating the costs of doing business
- Failing to take into account tax liabilities
- Failing to delegate non-essential duties
- Not relying on or taking advantage of professional advice
- Underestimating the competition
- Failing to effectively manage the business
- Not thinking through your long term goals and an exit strategy
From a legal perspective, the problems that most often arise include:
- A failure to comply with licensing requirements or other regulations
- Lax internal procedures and accounting standards
- Not staying on top of payables and receivables
- Labor and employment issues, including sexual harassment or discrimination claims
- Underestimating or failing to pay tax liabilities, including payroll taxes
- Disputes among partners
- Getting sued, with the risks of incurring substantial costs of litigation and exposure to any judgment against you or the business
- Possible criminal liability for violating laws regulating your business
A failing business may create significant personal exposure to the business person as follows:
- Personal guarantees on bank loans and other obligations of the business
- Unpaid taxes assessed against the business, including interest and penalties
- Other continuing or long term obligations of the company, which notably include office and equipment leases
- Pending lawsuits in which you are named personally as a plaintiff or defendant
- Investigations by governmental agencies
All of these risks underscore the need for proper planning before you go into business. This planning should include using the right business entity to shield you from the potential liabilities of operating a business.
Q: Under what different forms may I operate my business
A: Sole Proprietorships: One way to start up a business is as a sole proprietorship, in which you conduct business in your individual capacity rather than through a legal entity. You may operate the business in your own name or you may operate under a fictitious name, known as a "dba." Before legally doing business under a fictitious name, you are required to file a DBA certificate in the municipality or county where your business is located. Under this form, the business person is personally exposed to liability. Insurance policies can be purchased to provide protection, but there may be instances of uninsured claims or excess liability that may put the business person’s personal assets at risk.
Corporation: A corporation is a legal entity that the law treats as a "person" in the sense that the organization has its own corporate identity and existence. As a separate legal entity, a corporation serves as a shield between the owners and third parties doing business with the organization. So long as corporate formalities are observed, the corporate shield makes it difficult for third parties to "pierce the corporate veil" to go after the owners. Instead, creditors and other third parties can be limited to going after the assets of the corporation. A corporation also has its' own name and identity separate from the owners. It pays taxes and has the ability to contract. It can own property. A corporation can sue and be sued. In some instances, a corporation can be charged with and convicted of crimes. Corporations must be registered with the state in which their office is located and with any other state where it conducts business.
Partnership: A partnership is an arrangement involving two or more people undertaking a business venture as co-owners, with the intent to make a profit. The simplest type of partnership entity is known as a general partnership. Forming a general partnership is the easiest way to go into business with another person. But the simplicity of a partnership can also lead to problems, so careful planning is important. One of the principal drawbacks of a general partnership is that a general partner can be held responsible for all debts and liabilities of the partnership. Thus, a general partner with only a one percent interest in a business could still be held liable for 100% of the debts and liabilities of the partnership. From a tax standpoint, it's sometimes better to invest in a partnership rather than incorporating like a sole proprietorship, a partnership leaves each partner personally exposed to claims arising out of the business operations.
Limited Partnership: A limited partnership must have at least one general partner, but all of the other investors can be limited partners whose potential liability exposure can usually be limited to the extent of that partner's investment. So, for example, if a limited partner invests $10,000 in a business venture organized as a limited partnership, his or her potential liability would be limited to the $10,000 invested rather than the rest of the limited partner's personal assets. One of the resulting tradeoffs, though, is that an investor must take a passive role in the operation of the business in order to maintain the status of a limited partner. In many ways, a limited partner is comparable to a shareholder in a corporation.
Limited Liability Partnerships: A limited liability partnership is similar to a limited partnership, except that each member of the limited liability partnership has vote in managing the operation of the business. In addition, it also protects the members from personal liability from another member’s debts.
Limited Liability Company: A limited liability company is perhaps best described as a hybrid of a corporation and a general partnership. It's treated as a corporation for limited liability purposes but as a general partnership for tax purposes. The owners are called "members." Unlike a shareholder or a limited partner, they don't have to take a passive role in the business.
Q: What's an "S" corporation
A: Corporations are generally subject to federal taxation under Subchapter C of the Internal Revenue Code (and this is where the term "C Corp" comes from). However, in certain instances, a corporation can make an election to be treated under Subchapter S of the Internal Revenue Code. Under Subchapter S, a corporation is generally treated as a partnership for tax purposes. What this means is that income and expenses of the corporation pass straight through to the shareholders, which helps to minimize concerns about double taxation. In consideration of such special treatment, however, the shareholders of an S corporation must generally be individuals, and there can't be more than 75 in a corporation. There are a number of other tricky rules, including when you can decide to form an S corporation.
Q: What is a franchise
A: A franchise is not a type of business entity. Instead, it refers to an arrangement where someone (called the "franchisor") has developed a business idea and methodology that is packaged up in a plan that is sold to other individuals (called "franchisees") who want to go into business for themselves. Under a franchise agreement, the franchisee is authorized to use and market goods or services under the franchisor's trademarks, service marks and trade names for a specific length of time, usually in exchange for payment of a fee to the franchisor. A typical arrangement will require some payment up front and then a percentage of sales.
Many new business owners choose to purchase a franchise business because of the assistance they can get from a company in setting up and running the business. If you purchase a franchise from a reputable franchise company, the risks of opening a business may be significantly less than starting a new business "from the ground up."
The franchisor typically has strict rules and standards as to how business is conducted, the goods and services to be sold and the design and construction of the business location.
Each state has strict rules and regulations on franchises. Generally, franchisors must comply with strict disclosure requirements, so that people are fully aware of what they are getting into before they sign up to buy a franchise business. If you're looking at buying a franchise, you should be very careful to fully educate yourself about all aspects of the franchise relationship.
Q: Why do I need a lawyer to set up a business entity?
A: Although you can create and register your own business entity with the Secretary of State’s Office, additional documents may be needed to properly set up and organize your business entity. Corporate resolutions, incorporators’ agreements, by-laws, operating agreements, stock purchase agreements, and other documents may be needed to establish the relationship of relevant owners and management personnel to the business. Additionally, third parties may require specific documents prior to entering into business with you, consummating leases or other contracts, lending money, opening bank accounts, etc.
