Online Business Structures
By Sarah Jamieson
Online Business Structures: In most countries in the world, to run an online business you need to trade under an appropriate business entity. If you are just starting your internet business, you should not start trading without a proper business structure.
If you are already trading online and you are not doing so via a trading entity, then I suggest you consult your attorney as quickly as possible. How you trade or set up a business structure is a matter for you and your legal / accounting advisors.
You must do your own due diligence. Please see our Disclaimer. Setting up your business without being fully aware of the potential legal ramifications can be an expensive mistake. Consulting an attorney or accountnat is the wisest thing you can do.
The next image sets out various business structures - which generally apply in the US. Click a box for further information:
Almost three quarters of all businesses in the US are sole proprietorships. Many begin with this structure and then change to a corporation or partnership later on.
A sole proprietorship is one person doing business under a different name: basically you operate your own business.
You and the business are legally the same entity. This is the entity’s biggest advantage and also its biggest disadvantage.
Advantages of Sole Proprietorship
There are a number of advantages to setting up a sole proprietorship including:
Easy to start and end
You don’t need to do much paperwork to set up this kind of entity. If you don’t operate the business in your own name you need to file a Fictitious Name
Registration, or Doing Business As (DBA) form.
The form simply states that you really are the business for all legal purposes. Ask your lawyer about other forms you may be required to file.
It’s also easy to end your sole proprietorship: there is no waiting period for dissolution and no formal paperwork.
You receive all profits and losses
Your business profits or losses are reported directly on your personal income tax form.
All the income of your business goes directly to you, as the owner and operator, and, conversely, you may deduct all business losses from your personal income tax.
Inexpensive to set up
The cost to set up this type of entity is relatively minimal. Although costs vary, typically you will only pay a small business licensing fee and possibly a business tax.
Your lawyer or city and county officials can advise you about current requirements.
Tax-free asset withdrawal
The fluidity between your business and personal bank accounts is high, meaning that transferring money between your accounts is subject to few tax or legal requirements.
The same is true of business and personal assets.
One of the most attractive things about starting your own business is the control you have over every aspect of it.
With a sole proprietorship, you have no worries about organizational protocols such as a board of directors, and you don’t have to make anyone happy but your customers.
Disadvantages of Sole Proprietorship
There are a number of disadvantages in being a sole proprietor including:
The worst thing about sole proprietorships is that you are responsible for all business debts and employee liability that arises from business operations.
Your business assets as well as your personal assets such as your house and car are at risk.
Speak to a lawyer about asset protection or your accountant about errors and omissions insurance. If purchased correctly, it could pay legal fees in the event of a lawsuit.
Higher taxes for benefits
You generally pay more for Medicare and Social Security taxes that you would if you were an employee.
You may receive deductions for your Social Security and Medicare taxes and part of your health insurance premiums. Check this with your accountant.
Growth is slow until you can afford employees
Until you can afford to pay employees, you will have to do everything for your business.
You can only wear so many hats, and the growth of your business may be lower because you.re doing everything yourself; taking on more customers may have to wait.
More difficulty raising capital
Going it alone as a sole proprietor may slow the growth of your business. Lenders look at your personal assets when deciding whether you are a good loan candidate.
Getting a loan may be more difficult when you have no partners or investors to strengthen the business picture.
Owner’s death ends the business
Because you and your business are the same entity in the eyes of the law, your death also brings about the termination of your business.
Partnerships, as the name implies, are comprised of two or more people who own a business jointly. In many ways, a partnership is like a sole proprietorship.
Legally, the partnership is not a distinct entity; rather, it is considered to be all the partners working in tandem. Partners are liable for business debts and the business is sometimes terminated upon the death of one of them.
The really good thing about partnerships is being able to draw on someone else’s resources. Partners should be chosen carefully, since they will share in every aspect of the business with you.
Often a partner is chosen because of the professional skills, such as computer expertise, that they bring to the business.
A partnership can make many things easier: the effort of building a business, including financing, management, decision-making, and marketing, can all be shared.
There are different types of partnership structures, which are usually dependant on the relative involvement of the partners in the business.
The advantages and disadvantages below apply to most types of partnerships. There are exceptions that you can discuss with your advisor.
Advantages of Partnership
There are a number of advantages in operating under a partnership:
Easy to set up
Establishing a partnership is similar to establishing a sole proprietorship.
If you want to operate under an assumed name, you must file a “Certificate of
Conducting Business as Partners”
You may also need a business license and might have to pay a business tax.
Consult a lawyer about drawing up an Articles of Partnership agreement.
Partners share directly in profits
Easier to fund business
A partnership often is more likely to be approved for loans than a sole proprietorship.
The way the banks see it, there are more combined assets, and if something happens to one partner, there are others to take over the business and repay the debt.
No separate taxation
A partnership often has the advantage of not being taxed as a separate entity.
Partners simply report their individual portions of income or loss on their personal tax return.
Disadvantages of Partnership
Here are some of the disadvantages in setting up a partnership:
Each partner is an agent of the business
This means that any partner can enter into obligations that bind the other partners as well.
This is one area where a partnership agreement can be especially helpful.
For example, one of the partners may want to sell his share of the business; a partnership agreement can prevent this from happening without the other partner’s knowledge and consent.
All partners are personally responsible and liable for the business’s debts.
Partner’s death ends the business
This is another area where a partnership agreement can be helpful.
Normally, if a partner withdraws from the partnership or dies, the partnership structure, and consequently the business itself, is terminated.
With a partnership agreement, however, you can safeguard against this.
Types of Partnerships
There are three types of partnerships:
General, Limited, Limited liability
A general partnership simply refers to two or more co-owners of a business who agree, either verbally or in writing, to share all profits and losses of the business.
A general partnership does not presuppose an equal sharing, however.
Often partners will bring different levels of experience and capital to the business, and this may result in a decision to divide the business unevenly among the partners.
Limited partners are not allowed to participate in running the business in any way, but they can invest in the partnership and receive portions of the profits.
Their liability is limited to the amount of their investment.
If a limited partner takes an active role in the business beyond investing, he puts himself at risk of legally being considered a general partner and being liable for business debts.
A limited partnership does require at least one general partner who controls the business and also assumes personal liability for the partnership as a whole.
Limited partnerships are a little harder to set up than general partnerships.
Filing a Certificate of Limited Partnership is usually required, as is a written partnership agreement.
Limited Liability Partnership
Limited liability partnerships are basically general partnerships, with one difference: each partner is liable for her own misconduct, or that which takes place under his/her supervision, but not for that of any other partner.
This takes away the potentially crippling personal obligation found in general
partnerships for the actions of other partners.
When you enter into a partnership, it is advisable to have an attorney draw up a Partnership Agreement - also known as Articles of Partnership.
This document legally determines the rights and obligations of each partner. You may want to include the following in your agreement:
This provision only covers the initial start-up costs of the business, ensuring that each partner provides a given amount to adequately capitalize the business.
Sale of a partnership
This restricts a partner from disposing of his share of the partnership without the consent of the other partners, but additionally stipulates a means whereby the dissatisfied partner can leave the partnership.
Some partnerships have agreed that it is fair for the share of the business to be bought by the remaining partners; only if they refuse it can it be offered to outsiders.
Dispute resolution via arbitration
To prevent the deleterious effects on the business if partners decide to enter into expensive lawsuits against each other, this article provides for arbitration as the first and perhaps only means for settling disputes.
A partnership is automatically dissolved if one of the partners dies or is permanently disabled.
Formally agreeing to a buyout of the dead partner’s share of the business is one way to legally prevent the dissolution of the partnership and the ensuing problems it would cause your business.
Since dispute over management issues may potentially become an issue that would threaten the business, setting some guidelines in the partnership agreement is a good idea.
Under certain circumstances the powers of partners may need to be limited or enhanced. The agreement should also cover salaries and bonuses for partners.
A corporation, unlike a proprietorship or partnership, is a separate legal entity from its owners and employees.
It has its own rights and responsibilities.
The people who buy the stock of that entity own the corporation. They are known as shareholders.
The corporate form was created to provide limited personal liability, and this is still its greatest advantage.
Except in rare instances, shareholders are not personally liable for debts or misconduct of the corporation.
They can lose the amount of their investment in corporate stock, but not their personal assets.
One of the largest disadvantages of the corporate structure is double taxation.
The corporation is taxed once and when dividends (return on the stock investment), are paid to the shareholders, they must also pay personal income tax on those dividends.
Some countries have a system of dividend imputation, allowing the tax paid by the corporation to flow through to the dividend shareholders.
One way to avoid the double taxation pitfall is to structure the company as a Subchapter S Corporation.
A corporation is more complex, expensive, and time-consuming to set up and maintain than the types of business entities already discussed above.
To incorporate, you must file articles of incorporation and other forms, depending on the state in which you form the corporation, and often you will be required to pay an initial and annual filing fee.
And if you do business outside the state you incorporated in, you’ll have to register as a “foreign corporation” and pay an initial and annual fee there as well.
Management of a corporation is also complicated. The basic management of a corporation is structured like this:
- Shareholders elect a board of directors
- The board chooses officers to conduct business on behalf of the corporation and sets corporate policies.
- The officers run the corporation under the supervision of the board and are bound by its policies and decisions.
These protocols, and many others, such as annual meetings of the board, must be observed in order for the corporation to continue legally functioning under the law.
If the protocols are neglected, there is a real danger that someone suing the corporation can show that it is not a legally separate entity from its owners.
Shareholders could then be held personally liable for corporate debt or misconduct.
Now let’s take a look at the main advantages and disadvantages of a structuring your business as a corporation.
Advantages of Corporations
Here are some advantages of setting up a corporation:
Shareholders rarely stand to lose more than the amount of their share of stock.
The exceptions are when: Corporate protocols have not been followed which leaves the company open to charges that it is not, in fact, a separate legal entity from its shareholders.
A shareholder guarantees a loan to the corporation, which leaves that borrower personally liable for repayment.
Easier to grow the company
Because a corporation is composed of many people, it draws on the combined capital and managerial expertise of shareholders and directors.
Corporations are also able to raise funds by selling more stock; they are not
limited to the capital of their existing owners or to trying to secure loans.
Company lives indefinitely
Unlike partnerships and sole proprietorships, a corporation continues to exist
indefinitely, regardless of the death or disability of its original owners or transfer of stock.
Disadvantages of Corporations
There are several disadvantages of setting up a corporation.
Relatively expensive and complex to form
The corporate structure requires a number of forms and fees.
The extensive and fairly complex paperwork will require retaining an attorney for a longer period of time.
Taxes are paid twice, first at the corporate rate and a second time by each
individual shareholder as part of his/her annual income. Dividends are not deductible, but you can bypass double taxation by filing as a Subchapter S corporation.
Some countries, such as Australia, have dividend imputation – which is a form of not being taxed twice.
Shareholders who own less stock are not always given an equal voice with larger shareholders
More record keeping
Record keeping is a must because of the extra forms that are required for
Corporations and the ongoing filing schedules of both state and federal
Subchapter S Corporations
A Subchapter S, or simply S, corporation is more or less just like a regular corporation except in the matter of taxation.
S corporations elect to be taxed as a partnership. They aren’t subject to corporate income taxes. Instead, taxes, deductions, losses, etc. Are all passed on to the shareholders. Shareholders are then taxed at a maximum rate, as opposed to the top corporate rate.
Structuring an S corporation is more complicated than setting up an ordinary corporation.
Consult a lawyer, accountant or advisor before you make a decision.
Limited Liability Corporations (LLC)
An LLC can be a wise choice for a small business because it combines the limited
personal liability of a corporation with the taxation structure and limited formalities of a partnership.
There are three main disadvantages in setting up an LLC:
1. Since LLCs are a new form of entity, not every state has laws covering them. Thus, if you form the LLC in one state and then do business in another that
Doesn’t allow them, creditors from that state may be able to collect from you
2. A second disadvantage associated with an LLC is that some states only allow
them to exist for a certain period of time, often 30 years or even less.
3. LLCs are also more expensive to form than other types of structures, because they are more flexible and must be fitted to the owners’ needs.
All these considerations should be seriously taken into account they could be disastrous to your business if you don’t think them through.
With the above explanations and after consultation with your legal and accounting advisors, you should now be in a position to decide what sort body you want to register as your business trading entity.
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