Millions of new businesses are created each year. With little more than hope and an idea, against all odds, new business owners embark on that they believe is their life’s calling or take their hobby to the next level.

When starting a business, it is wise to think about how to legally set up the business, and to anticipate important legal issues you may face. I have a small business, The Raymond Experience. So I can speak from experience, pun intended, that having a qualified attorney and accountant to advise me on legal and tax issues is worth the price of their services.

So, where should you look for guidance and basic advice if you are just starting out? Lawyer Kathryn Van Voorhees of Van Voorhees Law was my first call. Kathryn received her undergraduate degree in political science, with a minor in economics, from James Madison University and earned her law degree from Washington University School of Law. Her practice involves matters of franchise law, small business representation, personal injury, class action, and collections.

Kathryn is not only a counselor, advocate, and problem-solver; she also views herself as a partner, working with her clients to solve legal issues. “One of my primary goals is to educate my clients and empower them so they can make informed decisions about their cases,” she explains.

So let the education begin.

Kathryn has been very generous with her time and knowledge, and the Legal Eagle 101 will be a series of blogs focusing on specific legal issues you should know about if you want to start a business or are already running full-steam ahead with a new business. In this first installment of the series, we are focusing on business entities.

Choosing which type of business entity you would like to operate as is extremely important and not to be taken lightly. According to Kathryn, “The entity will affect many aspects of the business, among them: tax treatment of income and expenses, legal liability, the continuity of the business, the acquisition of capital, transferability of business assets, management of the business, and liquidity of the business.”

Here is Kathryn’s overview of Sole Proprietorships and Limited Liability Corporations (we will cover partnerships in a future post).

Sole proprietorship – One person

Taxation: All income & expenses reported on Sole Proprietorship’s individual tax return.
Legal Liability: Unlimited
Continuity: Dies with proprietor
Capital: Limited to what Sole Proprietorship can secure
Transferability of assets: No problem because all assets of business are individually owned by Sole Proprietorship
Management: All management decisions made by Sole Proprietorship
Liquidity of business: At Sole Proprietorship’s discretion – treated as sale of assets of business
Upside: Inexpensive and simple to create and operate
Downside: Sole Proprietorship personally responsible for all business debts, can’t add co-owners later
Necessary documentation: Fictitious Name Registration to register business name.
Recommended documentation: Federal Employer Identification Number

Limited Liability Corporation (LLC) -  One or more members

Member(s) have limited liability for business debts, profits & losses can be allocated differently than ownership interests, IRS will allow LLC to elect whether it wants to be taxed as partnership or corporation.  Can later be converted to an S-Corp.

Taxation: Taxation of income and expenses is divided among members according to investment (or as allocated in the Operating Agreement) and each member reports her share on her individual tax returns.
Legal Liability: Limited.
Continuity: Members opt for perpetual LLC or to end at specified date.
Capital: Limited to what members can raise together.
Transferability of assets: A member’s economic interests are always transferable. Management rights are transferable when remaining members consent.
Management: Typically, members manage themselves but can use Operating Agreement to outline duties of non-members Managers.
Liquidity of business: Members are required to liquidate business at withdrawal of any one partner unless this is otherwise addressed by Operating Agreement.
Upside: Members have limited liability for business debts even if they participate in management, it’s not necessary to file annual documents to maintain flexibility in treatment for tax purposes.
Downside: typically more expensive to create than sole proprietorship or general partnership.
Necessary documentation: Fictitious Name Registration, Articles of Incorporation, Operating Agreement
Recommended documentation: Federal Employer Identification Number

S- Corp:

One Hundred Shareholders - All shareholders must be U.S. citizens or residents and must be individuals, estates or certain trusts- cannot be other corporations. S-Corp itself cannot be a member of an affiliated group of corporations.

Starting a business is not just about getting a store front, designing a website and printing business cards. It’s also about understanding the variety of legal aspects that can impact you and your finances.  But most importantly, it is about following your dreams.

Image from www.cranstonpolice.com

Pamela is an assistant editor at Girls Guide. She is the owner of The Raymond Experience, an events and public relations company, and she moonlights as the Business Commentary eXaminer for St. Louis, and writes XXRay Vision for ALIVE Magazine’s blog posse. You can email her at raymondcreative [at] yahoo [dot]com, and follow her on Twitter.