Entity Formations

Sole Proprietor
A business operated by one person, which business is not a registered entity of any State. A sole proprietorship exists when a person starts a business but does not register their business as an entity. Some pros to sole proprietorship are that they are easy to start; no formal registration with a State is required. Of course, depending on the nature of the business, registration may be required for the services such as licensure requirements for a plumber or a real estate sales person that may need to be licensed or registered with a State’s governing regulatory body. Some of the negatives of operating a business as a sole proprietorship include absolute exposure to liability and difficulty with corporate expansion. An example of such increased exposure; Assume Susan starts a truck delivery business. She leases commercial warehouse office space. Business is doing well so she expands and leases additional warehouse space. Then an unexpected downturn in the market requires Susan to down size her business as she no longer needs the additional warehouse rental space. However, the landlord for the additional rental space demands payment of rent from Susan. Susan can be sued personally, and the landlord could seek to collect a judgment against Susan and her assets. Taxes to the IRS on income and net profits are reported on the sole proprietorship owner’s individual tax return 1040 on Schedule C. For additional information on taxation of sole proprietors, see http://www.irs.gov/publications/p334/ar01.html

Limited Partnership
A limited partnership is similar to a standard general partnership, however, there must be at least one of the partners deemed a general partner. As a general partner, they are liable for the debts and obligations of the partnership. Contrarily, the limited partners are not. Like general partnerships, many States require limited partnerships to register as an existing business entity operating in the State. A partnership agreement is used among the general and limited partners to dictate the partners’ rights, duties, and obligations. Thus, a limited partnership is similar in many respects to a general partnership, with one essential difference. Unlike a general partnership, a limited partnership has one or more partners who cannot participate in the management and control of the partnership’s business. A partner who has such limited participation is considered a “limited partner” and does not generally incur personal liability for the partnership’s obligations. Generally, the extent of liability for a limited partner is the limited partner’s capital contributions to the partnership. For this reason, limited partnerships are often used to provide capital to a partnership through the capital contributions of its limited partners. Limited partnerships are frequently used for hedge funds, real estate transactions, and entertainment-related projects. Like a general partnership, however, a limited partnership may govern its affairs according to a limited partnership agreement. Such an agreement, however, will be subject to applicable State law. States have for the most part relied on the Revised Uniform Limited Partnership Act in adopting their limited partnership legislation. A limited partnership must have one or more general partners who manage the business and who are personally liable for partnership debts. Although one partner may be both a limited and a general partner, at all times there must be at least two different partners in a limited partnership. A limited partner may lose protection against personal liability if she or he participates in the management and control of the partnership, contributes services to the partnership, acts as a general partner, or knowingly allows her or his name to be used in the partnership business. However, “safe harbors” exist in which a limited partner will not be found to have participated in the “control” of the partnership business. Safe harbors include consulting with the general partner with respect to partnership business, being a contractor or employee of a general partner, or winding up the limited partnership. If a limited partner is engaged solely in one of the activities defined as a safe harbor, then he or she is not considered a general partner with the accompanying potential liability. Except where a conflict exists, the law of general partnerships applies equally to limited partnerships. Unlike general partnerships, however, limited partnerships typically file a certificate with the appropriate State authority to form and carry on as a limited partnership. Generally, a certificate of limited partnership includes the limited partnership’s name, the character of the limited partnership’s business, and the names and addresses of general partners and limited partners. In addition, and because the limited partnership has a set term of duration, the certificate must state the date on which the limited partnership will dissolve. The contents of the certificate, however, will vary from state to state, depending on which uniform limited partnership act the state has adopted.

Corporations
A limited partnership is similar to a standard general partnership, however, there must be at least one of the partners deemed a general partner. As a general partner, they are liable for the debts and obligations of the partnership. Contrarily, the limited partners are not. Like general partnerships, many States require limited partnerships to register as an existing business entity operating in the State. A partnership agreement is used among the general and limited partners to dictate the partners’ rights, duties, and obligations. Thus, a limited partnership is similar in many respects to a general partnership, with one essential difference. Unlike a general partnership, a limited partnership has one or more partners who cannot participate in the management and control of the partnership’s business. A partner who has such limited participation is considered a “limited partner” and does not generally incur personal liability for the partnership’s obligations. Generally, the extent of liability for a limited partner is the limited partner’s capital contributions to the partnership. For this reason, limited partnerships are often used to provide capital to a partnership through the capital contributions of its limited partners. Limited partnerships are frequently used for hedge funds, real estate transactions, and entertainment-related projects. Like a general partnership, however, a limited partnership may govern its affairs according to a limited partnership agreement. Such an agreement, however, will be subject to applicable State law. States have for the most part relied on the Revised Uniform Limited Partnership Act in adopting their limited partnership legislation. A limited partnership must have one or more general partners who manage the business and who are personally liable for partnership debts. Although one partner may be both a limited and a general partner, at all times there must be at least two different partners in a limited partnership. A limited partner may lose protection against personal liability if she or he participates in the management and control of the partnership, contributes services to the partnership, acts as a general partner, or knowingly allows her or his name to be used in partnership business. However, “safe harbors” exist in which a limited partner will not be found to have participated in the “control” of the partnership business. Safe harbors include consulting with the general partner with respect to partnership business, being a contractor or employee of a general partner, or winding up the limited partnership. If a limited partner is engaged solely in one of the activities defined as a safe harbor, then he or she is not considered a general partner with the accompanying potential liability. Except where a conflict exists, the law of general partnerships applies equally to limited partnerships. Unlike general partnerships, however, limited partnerships typically file a certificate with the appropriate State authority to form and carry on as a limited partnership. Generally, a certificate of limited partnership includes the limited partnership’s name, the character of the limited partnership’s business, and the names and addresses of general partners and limited partners. In addition, and because the limited partnership has a set term of duration, the certificate must state the date on which the limited partnership will dissolve. The contents of the certificate, however, will vary from state to state, depending on which uniform limited partnership act the state has adopted.

Limited Liability Company (“LLC”s)
Like corporations, LLCs are business structures authorized by State laws. LLCs are also akin to corporations as the owners have limited liability to the debts and actions of the LLC, save for certain exceptions. Owners of LLCs are typically called members, and their ownership interest is often represented by “units”, similar to shares of stock of a corporation. The determination of the LLCs operations of LLCs are typically set forth in the operating agreement, which is like a partnership agreement to a partnership, and a shareholders’ agreement to a corporation. The members nominate the managers or managing board of the LLC, which is similar to a board of directors of a corporation, who in turn appoint officers. LLCs are typically taxed like partnerships, referred to as “pass-through entities” as the taxes due on the income from LLCs is reported on the members’ individual income tax return; the LLC itself typically does not pay taxes on its income or profits. An LLC can be owned by one person, a single-member LLC, or by an unlimited number of persons. There are certain restrictions on who can own an LLC; for example, banks and insurance companies cannot operate as an LLC. LLCs are often viewed as hybrid entities, a cross between a corporation and a partnership. LLCs have been more widely used since the Internal Revenue Code of the United States of America changed its laws related to taxation of LLCs in 1988 such that the owners of the LLC can choose to be taxed either a partnership for pass-through taxation purposes or like a standard corporation with double taxation. Before such changes, LLCs were subject to double taxation, making their use much less desirable. Now, with the current pass-through taxation benefits, yet operationally effectiveness of a corporation, coupled with the flexibility of partnerships as far as determining distributions of net incomes disproportionately among the members, LLCs have become widely used business entities in the United States. Some of the benefits of an LLC as a business entity over the other business entities include: -All of the owners of LLCS have limited liability exposure such that they are typically only liable for debts and obligations of the LLC up to their capital investment; -LLCs offer pass-through taxation; -Sub-chapter S corporation has some restrictions, violation of which can cause an S corporation to be deemed a C corporation and be subject to double taxation; however, LLCs do not; -I.R.S. “at-risk” limitations of corporations, and even some limited partnerships, typically are not applicable to LLCs; -LLCs have broad structural and organizational options which give LLCs more simple operating efficiency and effectiveness; State laws may result in State taxation of LLCs that are not uniform throughout the United States. For example, Florida does not require a general tax for LLCs, and there is no Florida State income tax. However, New York and Texas, for example, do have a State income tax structure applicable to LLCs that is in addition to any Federal income taxes.

Joint Venture
A joint venture is akin to a partnership in that it is a combination of two or more parties that come together to conduct a business operation, however, the operation is specifically defined. So when the operation is complete, or upon the expiration of a stated period of time, the joint venture concludes. For example, two construction companies may cooperate for the construction of a $250,000,000 hybrid commercial/residential construction project, but once the project is complete, the joint venture terminates. A joint venture nearly always operates under the defined terms of a joint venture agreement. In most other respects, a joint venture and partnerships are similar. A joint venture can be seen as a contractual business endeavor involving two or more parties. It is similar to a business partnership, with one key difference: a partnership generally involves an ongoing, long-term business relationship, whereas a joint venture is based on a single business transaction. Joint ventures are usually done so that companies’ respective strengths can be maximized while risks of losses can be minimized. It is another way of sharing the competition in the marketplace. Joint ventures can be distinct business units (a new business entity may be created for the joint venture) or collaborations between businesses. In a collaboration, for example, a high-technology firm may contract with a manufacturer to bring its idea for a product to market; the former provides the know-how, the latter the means. Joint ventures typically start with a contract that delineates the joint venturers’ respective and mutual rights, duties, and obligations. The contract is crucial for attempting to avoid trouble later; the parties must be specific about the intent of their joint venture as well as aware of its limitations. Joint ventures typically involve certain rights and duties. The parties have a mutual right to control the enterprise, a right to share in the profits, and a duty to share in any losses incurred. Each joint venturer has a fiduciary responsibility, owes a standard of care to the other members, and has the duty to act in good faith in that concern the common interest or the enterprise. A fiduciary responsibility is a duty to act for someone else’s benefit while subordinating one’s personal interests to those of the other person. A joint venture can terminate at a time specified in the contract, upon the accomplishment of its purpose, upon the death of an active member, or if a court decides that serious disagreements between the members make its continuation impractical.

Business Trust
A business trust has been around for many years. It is a legal entity that was used to circumvent the formalities and restrictions required of registered corporations. It is used to try to limit liability much like a corporation limits liability to the shareholders. A business trust does not have to receive any chartered recognition from a State, however, some State such as Florida requires that such a business trust file a declaration of trust with the Florida Department of State, Division of Corporations (Fla. Stat sect. 609.04). The business trust comes into status from the act of the individuals who form them. Like a traditional trust, a business trust provides for the trusts’ trustee to take the title of trust assets and property and to administer such assets for the benefit of the trusts’ beneficiaries. A written declaration of business trust is drafted to specify the terms of the trust, its lifespan is delineated, the trust beneficiaries’ rights and the business trusts’ purpose the trust was established. The powers and restrictions on the trustee are also set forth. Beneficiaries of the business trust are given certificates of beneficial interest which represent their interest in the trusts ‘ assets. Typically, such certificates are transferable. Some States limit some activities a business trust may engage in.

Foreign Entities Outside of the U.S.
While the common business entities used in the United States of America include sole proprietorships, partnerships, corporations, LLCs, and business trusts, other countries have similar as well as other entity structures for chartered businesses. For example, in the United Kingdom (England, Northern Ireland, Scotland, and Wales) partnerships, limited partnerships, limited companies, and unlimited companies are used. Canada allows entities to be formed under the federal or provincial law, and the most common entity form is the unlimited liability corporation recognized under Canada’s Business Corporations Act. Foreign business entities may conduct business in the United States of America