Most attorneys, myself included, take for granted how little most individuals know about corporation law and business entities. The distinctions between the different types of entities that can be created are substantial and have a tremendous legal effect on how the business operates from year to year.
There are four basic categories of business that can be formed by an individual or groups of individuals: 1) sole proprietor, 2) partnership, 3) limited liability company (aka LLC) and 4) corporation (aka Inc.). All of these entities have varying degrees of complexity regarding start-up and more importantly varying degrees of liability toward the persons in charge and who started the entity.
A sole proprietor is the most simple way one can start up a business, yet it can be the most dangerous for the person who starts it because the individual assumes all of the company’s liabilities. If the company gets sued or defaults on a loan then the assets of the sole proprietor is not protected. A sole proprietor is typically when you will have a person’s name, example: John Smith d/b/a Smith’s Painting. Any suit against Smith’s Painting will be against Smith personally. This is not a safe strategy if a person is trying to protect his assets. In the business world, sole proprietors are not the way to grow a strong and thriving business. For more click here.
Partnerships at one time were very popular and they are very easy to start. Partners share liability according to their partnership agreement, which is the framework for how the partnership operates. In the absence of an operating agreement the business code (Title 2 of the California Business Code) has default rules on how this type of entity operates. Here, liability is still personal but it is shared between the partners only involving partnership business. If one partner commits a tort or acts outside of the partnership agreement other partners may not be liable for the faulty partner’s debt. Over the years there have been many types of variations to the partnership model including, general partnerships, limited partnerships and limited liability partnerships. For more on how partnerships function in California click here.
The next two types of business entities are the limited liability company (“LLC”) and corporation (“Inc”) can be very complex and warrant a much further in depth analysis that this medium can offer. Luckily for all non-lawyers who did not have to sit through hours of class on the subject, the California Secretary of State offers a wealth of information on existing LLC’s and Inc’s but more information on how to start your own business. The glory of the LLC and the Inc is that there is a corporate shield of liability for members (LLC) and directors/shareholders (Inc.). This means that if the entity is sued then the individuals who started have their assets protected. The only way this shield can be breached is through a theory called piercing the corporate veil.
Overall the Inc is much more complex and has many more formalities than does an LLC. The LLC was created in the 1990’s hybrid of the partnership ease of formation and lack of formalities and the Inc’s limited liability status. Today the LLC is vastly becoming the most popular entity formed California and nationwide, for good reason. Unless you plan on starting a complex, potentially large company the LLC is the way to go. Contact an attorney to best advise you on which entity is best for your new business. See Title 1 for Inc and Title 2.5 of the California Corporations Code for more detailed information.