Working in corporate America used to be the goal, but nowadays for many Californians, the 9 to 5 is no longer the preferred form of employment. Indeed, more and more entrepreneurs are venturing out to work for themselves. For some, that means joining together with family to start a small business. And while starting a family business definitely has its perks, such as working with people you trust, a family business also has its inherent vulnerabilities.
The oft-ignored vulnerabilities specific to a family business are financially and legally related. Many times, family members take a more casual approach to forming the business, thinking contracts and paperwork can come later, if ever. Unfortunately, this approach can place all involved at risk down the road.
The first step in protecting yourself in your new business venture is to choose the proper legal structure for your business. The choice may not always be clear, but as it will have various legal, tax, and other financial implications to you, it is important. Discuss with an experienced business formation attorney in Los Angeles which business entity is best suited for your circumstances. The most common entities for small family businesses are sole proprietorships, general partnerships, limited liability partnerships, and limited liability corporations.
Many small business owners choose the route of sole proprietorship, but for a family business with multiple partners, this may not be a preferable option. One of the perks of a sole proprietorship is that it does not require filing any legal documents with the Secretary of State. You will still need to obtain the requisite permits, licenses, employee identification number, and fictitious business name, but the actual formation of the entity does not require any filings. Additionally, a sole proprietorship is easy to set up and the sole proprietor is only taxed on the income from the business (no double taxation). On the other hand, a sole proprietor is personally liable for the debts and obligations of the business.
A general partnership is formed when two or more people carry on as a business for profit. A general partnership has many of the same pros and cons as a sole proprietorship. The entity does not require any formal filings to be created and provides for pass through taxation, but all partners will have unlimited personal liability.
In contrast to a general partnership, a limited partnership requires filings with the Secretary of State in order to be established. Just as with a general partnership, a limited partnership requires two or more people to create the entity, however here at least one person will be designated as the general partner and at least one person will be designated as the limited partner. The general partner has management authority and personal liability, whereas the limited partner is merely the passive investor and has neither management authority nor personal liability.
Limited Liability Corporation
Limited liability corporations have been a very popular business entity choice because of its pass through taxation and limited personal liability of all its members, including its managing member. However, note that each member’s share of the profits represents taxable income whether or not the shares of profit are distributed. Formation of a limited liability corporation requires filings with the Secretary of State.
Corporations are a smart choice for family businesses looking to expand, as they offer the ability to sell ownership shares in the business through stock offerings. Corporations are more complex than other business structures because they tend to have costly administrative fees and complex tax and legal requirements. For more information on the pros and cons of a C-corp or S-corp for a California business, contact an experienced business attorney.
To discuss the most appropriate entity for your small business, contact Los Angeles business lawyer Drew E. Pomerance today.