If you plan to start a business in California, you are likely considering which form your venture should take. For example, a business may be organized as a sole proprietorship, led by one person who is the owner and operator of the establishment or set up as a type of partnership. Many businesses are formally incorporated, which provides an important level of legal protection, along with other financial and legal advantages.
Most businesses start out as sole proprietorships, meaning the owners take no formal steps to formalize the business and make no public filings. While this is inexpensive, the consequences of not setting up a formal business entity can be severe.
Concerns about Liability
The first consideration is liability. Sole proprietorships that are set up informally are seen as an extension of you, the owner. A sole proprietor has unlimited and direct liability and is legally responsible for debts against the business. This means both the business assets and your personal assets may be at risk. If you are sued, a judgment will be issued in your name personally. Some people think using the “doing business as” (DBA) moniker will protect them, but this is simply a trade name that will not create a separate legal entity or protect you from liability.
Liability is also a concern for a general partnership. If the partners are sued, each partner is jointly liable for the entire amount of any business debt, even if the other partner incurred the debt. The partners would be held personally liable as with a sole proprietorship. There may also be an issue with proving the partnership exists, because an unincorporated general partnership is defined by its lack of formality. On the other hand, a court could presume a partnership by the partners’ behavior, even if the partners never intended to create a partnership.
Funding Issues to Consider
Another consideration with informal entities is funding. Without incorporation, it may be harder to take out business loans and prepare to open the business because you will likely be limited to personal loans or consumer loans. In today’s competitive business market, many banks and lenders only do business with legal entities that are registered with the Secretary of State (and other agencies) and have some public accountability. Lenders will want to see formal incorporation documents, profit and loss statements, and other signs of legitimacy and solvency before making a loan.
Dissolving an Informal Business
Finally, informal entities have no stability when it comes to ending the business, or dissolution. Because a sole proprietorship is an informal structure that is an extension of the owner, the business entity dissolves automatically upon retirement or death of the owner. An informal general partnership works the same way: it has limited life and dissolves when a partner withdraws, goes bankrupt, or passes away.
To discuss taking steps to properly form your business, contact experienced business attorney Drew E. Pomerance today.