Answer 6 questions before forming firm

Not too long ago a friend of mine received a call from the CEO of a company in which he was invested asking him to "unwind" his investment due to an organizational conflict.

My friend was part of a group of local investors who had provided the first round of financing for a promising high-tech company. Funds invested in the new company came from the investor’s LLC. The CEO had intended to form an S Corp., but now the investment was forcing him to adopt a C Corp. designation. Unwinding the deal will be difficult, as the original investment was made in calendar year 2003.

By Gary Williams
Brigham Young University

http://deseretnews.com/dn/view/0,1249,595054873,00.html

Impossible? No. But definitely inconvenient. Not to mention embarrassing.

In order to avoid troublesome situations like this, take the time to study the pros and cons of the different types of organizations. Before you can select the right business form, you need to answer six questions:

* How many owners will be involved in the business?

* Who will own the "liabilities" of the business?

* How will profits be distributed? In other words, who will pay taxes on the profits?

* Do you want to transfer interest in the company at some future date?

* What is the intended life of the company? Will it dissolve on your death?

* Who will control the company (management)?

Careful consideration of these issues prior to forming the company will allow you to make an informed decision that will impact both your business and personal lives.

The most common business forms include: sole proprietorship; partnership (limited partnership has some differences); limited liability company; S Corp.; and C Corp. A comparison of each business form follows.

* Number of owners: One for a sole proprietorship, 75 with an S Corp. Other organizations are generally unlimited.

* Who has liability: The owner of a sole proprietorship assumes liability. In a partnership, liability falls to the general partners, while the liability of owners of other business forms is generally limited to the amount of their investment. Profits and tax liability are distributed to owners, partners or members in all business forms except in a C Corp., where owners may receive dividends.

* Transfer of ownership: In a proprietorship the owner is free to sell. In a partnership the general partner must usually have the consent of the other partners to sell. Ownership of the LLC is typically not restricted but is subject to the organizational agreement. An S Corp. is also subject to the agreement. In a C Corp. shareholders are free to sell their stock subject to SEC guidelines.

* Life of business: A sole proprietorship dissolves upon the death of the owner. The same is true for a partnership unless specified in the agreement. Other forms continue beyond the death of an owner.

* Management control: The owner has full control in a proprietorship, while partners share control in partnerships. Management has control in an LLC, the owners control in an S Corp., and in C Corp. the board of directors (appointed by shareholders) control.

Consider the above points as general guidelines. Other issues exist, including the type of entity that can invest in business forms, as my friend so frustratingly discovered.

Founders will often make choices based upon their projections of early profit and loss.

Bookstores and libraries have an abundance of books to guide the business founder in considering the correct form of organization. Your legal and tax experts can also be helpful in determining what form is best for you.

Gary Williams is affiliated with the BYU Center for Entrepreneurship. He can be reached via e-mail at [email protected].