Starting a New Business: Which Business Entity is Best for you?

By Alex Yorkoa

Many people who wish to start a new business in Colorado wonder which type of business they should form because there are several different options. You can choose to form a corporation, a partnership, a limited partnership (LP), a limited-liability company (LLC), a limited-liability partnership (LLP), a limited-liability limited partnership (LLLP), or a limited partnership association (LPA). Deciding which entity to form is a big decision, and it can be very confusing without first knowing the positive and negative consequences of each entity.

 

Choosing to Form a Corporation

Historically, prospective business owners chose to form corporations because these types of entities limit the personal liability of directors, officers, and shareholders to the amount of their investment.[1] That means that if an employee of the corporation negligently injures another employee at work, the injured party cannot sue the director to attempt to collect from the director personally.[2] Instead, the injured party would have to sue the corporation to receive compensation.[3] Recently, many business owners have chosen not to form a corporation because they want to avoid double taxation.[4] Corporations are taxed both at the corporate level and then the individual shareholders are taxed at their individual tax rate.[5] However, one could avoid this double taxation by filing as an S-Corporation. Corporations have several formalities that the corporation must comply with. It is best to work with an attorney to draft the articles of incorporation and corporate by-laws. Otherwise, there is a risk that you may contract for something that was not your intention because of ambiguous terms, undefined terms, contradictions in the agreement, or violations of the law in your agreement. The last thing you want is to end up in court to have the judge determine the meaning of a phrase. It is best to tackle these problems before they arise.

 

Forming a Partnership: Partnership, LP, LLP, LPA, or LLLP?

Partnerships are popular because the partnership is not taxed. Instead, a partnership enjoys pass-through taxation. A general partnership is probably one of the easiest entities to form possibly because these entities do not necessarily require a written agreement, there is no filing requirement with the state for a general partnership, and individuals can form a partnership inadvertently since a partnership is defined as “an association of two or more persons to carry on, as co-owners, a business for profit.”[6] In a regular partnership, all partners are “jointly and severally liable for everything chargeable to the partnership.”[7] The following scenario illustrates the potential problems with general partnerships: John, Mary, and Kate form a general partnership to create software. John contributes $90,000, Mary contributes no money but contributes intellectual property, and Kate contributes no money but contributes her knowledge of the industry. If the partnership loses all $90,000 and the business shuts down, the $90,000 will be split equally between the partners (absent an agreement to the contrary). Additionally, if John decided to take out a $150,000 loan on behalf of the partnership, each partner would be jointly and severally liable for the debt. Lastly, partners are generally not protected from liability for the torts committed by employees or other partners. However, one can avoid the problems illustrated by forming an LP, LLP, LPA, or an LLLP. Unlike a general partnership, these entities require filing with the state. It is best to consult with an attorney to determine which partnership entity is the best option for you to form and to aid you in drafting the partnership agreement.

 

Limited Liability Companies

An LLC can by one person or more “by delivering articles of organization to the secretary of state.”[8] These entities have become very popular in the last thirty years because of pass-through taxation, the liability protection of members, and the flexibility of these organizations. These operate similarly to a corporation, but they are much more flexible, and they have the same tax advantages that partnerships have. LLCs have less formalities, restrictions, and regulations than regular corporations. For LLCs, it is important to work with an attorney to have a well-drafted operating agreement.

 

Taking the Next Step to Form a New Business

When forming a new business, it is best to seek legal counsel to (1) determine which is the best entity for you to form, (2) outline the powers of different officers and actors within the corporation, (3) draft employment contracts for prospective employees, (4) go over the tax consequences of each business entity, (5) decide which insurance is best for you, and (6) draft the agreement between the parties. As previously stated, you can avoid court battles by working with an attorney to get everything that is in your head into the agreement. This will save you time, money, and the headache of going to court.

 

Contact Columbine Law Group, PC for a consultation on your business needs! 720-787-7870

 

[1] Colo. Rev. Stat. § 7-108-402 (2017).

[2] Id.

[3] Id.

[4] Colo. Corporate Forms § 1:1 (2d ed.).

[5] Id.

[6] Colo. Rev. Stat. § 7-60-106 (2017).

[7] Colo. Rev. State. § 7-60-115 (2017).

[8] Colo. Rev. Stat. § 7-80-203 (2017).

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