Below is an overview of different business structures to help you determine which is best for your business in Oregon. At every stage your business will likely best be served by one particular structure based on those involved, operating formalities, management, liability, and tax implications.
The purpose of this article is to outline the different types of business entities, their advantages and disadvantages, and help you select the best structure for your business right now.
Do I need a lawyer for this? Read on and find out!
Different Types of Business Entities
The principal business legal structures are as follows: sole proprietorship, general partnership, limited partnership, C corporation, S corporation, professional corporation, nonprofit corporation, limited liability company (LLC), limited liability partnership (LLP), and B corporation (benefit corp).
Sole Proprietorship
A sole proprietorship (or sole trader) is a type of business owned and run by a single person (the sole proprietor) who makes all the business decisions and enjoys all the profits. There is no distinction between the sole proprietor and the business. This is the simplest way to start a business and does not require registration with the state. The sole proprietor is responsible for all of the obligations and debts incurred by the company and as such has unlimited liability.
Partnership
A partnership is more sophisticated than a sole proprietorship in both starting and running it. A partnership starts when two or more people co-own a business and share the profit, loss, and liability. Each owner contributes something to the business, such as money, ideas, property, or a combination of these. Profit share, management rights, and personal liability vary depending on the type of partnership the business is: general, limited, or limited liability partnership.
- General partnership
The general partnership involves two or more owners sharing equal rights and responsibilities. All partners are personally liable for business debts and obligations. Any individual owner can bind the entire group to a legal obligation.
- Limited partnership
With a limited partnership some partners can restrict his or her liabilities to the amount of his or her investment. However, this option is not open to all partners. At least one partner must accept general partner status which exposes him or her to full personal liability for the business’s obligations and debts. This partner must be a registered agent in Oregon. The general partner has the right to control the business while the limited partners take no part in management decisions. All the partners (limited or general) benefit from profits of the business.
- Limited liability partnership (LLP)
A limited liability partnership (LLP) is a form of partnership in which all partners have limited liability. It is restricted to professionals offering services that also require a license as defined by ORS Chapter 67. An LLP has elements of a corporation and partnership. Generally speaking, no partner is liable or responsible for the negligence or misconduct of another partner. In states such as Oregon, LLPs are popular among professionals such as architects, accountants, lawyers, psychiatrists, chiropractors, dentists, or other services substantially similar to those listed. For one to form an LLP, he or she needs to fill certificates with Oregon Secretary of State’s Corporation Division.
C Corporation
Class C corporations are formed when a business incorporates into a business entity. C corporations are viewed as an entity separate from its owners. The owners become shareholders. In other words, the shareholders are liable to the extent of their investment in the corporation. In case the corporation is sued, the shareholder’s personal assets are generally not on the line as they would be if the business were a sole proprietorship or partnership. As a separate entity, a C corporation must file its tax returns. A corporation is managed by a board of directors appointed by the shareholders, the number of which is determined by the bylaws. The directors elect a president, treasurer, and secretary. Oregon requires a registered agent and a physical street address which serves as a registered office. The registered agent can be a legal entity or an individual.
S Corporation
S corporation is a special form of corporation allowing protection of limited liability but direct flow through of losses and profits. Most small business owners prefer S corporation to C corporation because S corporation has appealing tax benefits and provides business owners with the protection of a corporation. Shareholders in an S corporation share income and losses. For a corporation to become an S corporation, it must have no more than 75 shareholders, where a husband and wife count as a single shareholder. Only the following entities may be shareholders: estates, individuals, certain partnerships, certain trusts, charitable organizations, tax-exempt, and other S corporations. You can choose between a C corp or S corp after you form your corporation.
Professional Corporation
Professional corporations also called professional service corporations are corporate entities designed for professionals such as accountants, lawyers, engineers, and dentists providing specialized services to companies. All of the shareholders of a professional corporation must be licensed to render the selected professional service.
Nonprofit Corporation
A nonprofit corporation is a business serving some public purpose, and it gets special treatment under the law. These forms of business entities can make profit contrary to their name, although they are not designed for making a profit. Nonprofits may be eligible for given benefits, such as income, property, and sales tax exemption at the state level, unlike for-profits. However, the IRS clarifies that despite nonprofits being federal tax-exempt organizations, organizing a nonprofit at the state level does not grant the nonprofit an automatic exemption from federal income tax.
Benefit Corporation
Benefits corporations are a new business structure designed to establish long term, mission-driven growth based on expanded purpose, transparency, and accountability beyond just making profits for shareholders. They are required to make publicly available a yearly report reviewing social and environmental impact by a third party designated by the state of Oregon. B corps are taxed like C corps.
Limited Liability Company (LLC)
An LLC is a type of business organization that benefits from a liability shield like a corporation, but has the flexibility and tax pass-through of a partnership. An LLC is unincorporated, has members instead of shareholders, managers instead of a board of directors or limited partners, and have operating agreements instead of bylaws. Much like corporations LLCs must have a registered agent and a registered physical office which may be an individual or legal entity.
Advantages and Disadvantages of Different Types of Business Entities
Sole Proprietorship
Advantages- Easy to create and maintain
- A sole proprietor has complete control and decision-making power over the business
- Sale or transfer can take place at the owner’s discretion
- Benefits from pass-through tax treatment
- Owner establishes the business with few associated fees
- Owner is able to deduct a net business loss from their personal income taxes
- The sole proprietor is personally liable for all judgments, debts, and other liabilities
- This risk extends to any liabilities incurred as a result of acts committed by employees
- If the owner passes away it does not continue unless transferred to heirs, but when it is transferred a new sole proprietorship is created
- Not generally attractive to investors
General Partnership
Advantages- Easy to create and maintain
- Simplicity and flexibility
- Few associated fees to create it
- Benefits from pass-through tax treatment
- Each partner files the profits or losses of the business on his or her own personal income tax return
- Owner can deduct net losses from personal income taxes
- Partners share financial resources and commitment
- Increased ability to raise investment
- Improved management potential with more than one owner
- Potentially larger pool of knowledge, skills, contacts, and experience to share
- Owners are personally and jointly liable for all judgments, debts and other liabilities
- This risk extends to any liabilities incurred as a result of acts committed by employees
- A partner cannot transfer interest in the business without consent of all partners
- Partnerships can be unstable and result in dissolution if one of the partners dies or wishes to withdraw from the business
Limited Partnership
Advantages- Easy to attract investors
- Limited partners enjoy limited liabilities for their judgments, debts and other liabilities
- Benefits from pass-through tax treatment
- General partners focus their attention on the business freely
- General partners can raise cash without reducing their control of the business
- Limited partners can leave the partnership without dissolving the entire partnership
- General partners are personally and jointly liable for judgments, debts and other liabilities
- Limited partners can become general partners losing their liability shield if they get actively involved with the business
- Are more expensive to create and maintain
- A certificate of limited partnership must be filed with the state along with associated fees
C Corporation
Advantages- Shareholders may lose their investments but benefit from limited liability for judgments, debts and other liabilities
- Pooling of capital, knowledge, experience and contacts can be powerful and accelerate growth
- ome benefits deducted as business expenses
- More expensive to start up and maintain
- Requires filing articles of incorporation and other paperwork with the secretary of state
- Double taxation. The profits of the corporation are taxed as they are earned as well as when dividends are paid out to shareholders.
S Corporation
Advantages- Shareholders may lose their investments but benefit from limited liability for judgments, debts and other liabilities
- Benefits from pass-through tax treatment unlike a C corp
- More expensive to create and maintain than partnerships and proprietorships
- Requires filing articles of incorporation and other paperwork with the secretary of state
- More complicated than an LLC
- Owner interest is often dependent on income from dividends
Professional Corporation
Advantages- Similar advantages and disadvantages to S corporations and C corporations but owners must be members of certain professions
- Corporations must use an accrual method of accounting for calculating taxable business income whereas a professional corporation is designated as a personal service corporation and is eligible for the cash method of accounting which allows deferring tax payments until payments for services are received
- Generally professional corporations are subject to a 35% tax rate on all earnings whereas C corporations are subject to a maximum tax rate of 35% which progressively increases from 15%.
Nonprofit Corporation
Advantages- Does not pay federal income taxes
- Contributors may deduct their contribution from income taxes
- Given benefits can be deducted as business expenses
- Only businesses incorporated for literary, religious, scientific, educational, or charitable purposes can use full tax advantages
- No shareholder or individual may receive net profits from the organization
Benefit Corporation
Advantages- B corp is to business what Fair Trade certification is to coffee
- B corporations can encourage investment due to adherence to goals beyond profit
- Is driven by a message which can resonate with customers and power prosperity
- Voluntarily must meet higher standards of transparency, accountability, and social impact
- Must submit a yearly report which adheres to state selected third party standards
- Must absorb the costs of adhering to higher social and environmental standards
Limited liability Company (LLC)
Advantages- Limited liabilities for judgments, debt, and other liabilities
- Losses and profits allocation is not fixed
- Owners have choices on how LLC will be taxed either as a corporation or as a partnership
- Flexible profit distribution in comparison with partnerships
- Benefits from pass-through tax treatment
- No formal minutes
- Are more expensive to start and maintain than partnerships and sole proprietorships
- More paperwork than partnerships
- LLC is dissolved when a member dies or undergoes bankruptcy
Things to Think About for Partnership Agreements, Corporate Bylaws, or LLC Operating Agreements
The cornerstone of every business entity is a set of documents that dictate how the entity will function. For corporations, the primary document is the corporate Bylaws. For LLCs, the primary document is the Operating Agreement. Many people believe that these documents are only necessary for business with multiple owners, such as a partnership, a corporation with multiple shareholders, or an LLC with multiple members. However, even a business with a single owner can benefit from these documents. They can lay out operating guidelines and rules for when the business is sold or a new partner joins the business.
Here Are Some Topics You Should Consider:
Contributions
The agreement should highlight each partner’s stake in the formation and operating costs of the business. In other words, the agreement should include the amount of money that each partner will contribute to starting the business and the responsibilities of each partner. This should include not only monetary contribution but also equipment, customers, labor, time, know-how, or good will.
Distributions
How the partners will split the business profits? This includes how much each partner will receive, terms, and which partner will be paid first.
Ownership
The agreement should indicate what each partner gets when the business is sold. It should also explain partnership positions when adding new partners. The agreement should direct what happens if one partner wants to withdraw or what happens in a buyout. The agreement should describe carefully how the company or corporation would handle ownership interests in various scenarios such as withdrawing, retirement, death, or even bankruptcy. The agreement should also protect the company from partners who leave the original company, form similar companies, and potentially take away customers in the form of non-compete clauses or other arrangements.
Decision Making
The agreement should define long-term decisions and day-to-day management of the business. It should define who gets the final say and what types of decisions require unanimous vote by the partners. The more detail is in the agreement the more likely partners will share common ground and be able to collectively set their expectations. Sometimes partners disagree and having dispute resolution parameters set in the agreement can relieve a great deal of stress and uncertainty.
Dispute Resolution
Disputes are not inevitable in the partnership business, but the agreement should define methods of resolving such disputes, such as mediation, arbitration, negotiation, or any other method that protects the business and allows each partner to share their perspective. Disputes which escalate into litigation become part of public record. It’s also no secret that taking matters to court can be prohibitively expensive and be a drain on the business.
Changes
Changes are inevitable in business. The agreement should describe how to deal with different scenarios, changing interests, sickness of the partner, buyout, retirement provisions, taking the business in new directions, a partner moving out of state, a partner taking a long break, and any other potential concern. The more detail and clarity the better.
Dissolution
There can come a time when business partners need to part ways. In such circumstances the agreement needs to define the steps partners need to take to end their partnership.
Benefits of Hiring an Attorney
Business formation is a legal matter, and not everyone can act as a lawyer. Good business formation attorneys can provide knowledge, experience, and insight to help determine basic corporate compliance, employment matters, zoning compliance, and even trademark and copyright advice. Perhaps most importantly a lawyer can help partners create solid common ground and help them set their expectations of each other.
The Bottom Line
Forming a business requires planning and choosing the right business entity. Each business entity gives entrepreneurs different advantages regarding partners’ responsibilities and taxes depending on the nature of the business, Oregon law, and doing business across state lines. Once you get the right business entity that suits your venture, you need to prepare the business documents that bind partners. If you or your partners can set aside ample time and feel comfortable putting in the research you may be able to move forward yourself. If, however, you feel like you have your hands full already, getting a business formation attorney involved can be well worth the fees.
Frequently Asked Questions
Does it really matter what business structure I choose at the beginning?
Yes. Each business entity has different rules, different advantages and disadvantages, and can influence growth and direction for the company. More importantly, you and your partners are going to want to think about how each structure can support your transition from where the business is today, and where you envision it should be in the future.
Can I change my business entity from one type to the other later?
Yes, but planning in advance can make a big difference. It does not matter what type of business type you start with – LLC, partnership, or sole proprietorship – you can change later. You may start with a type of business entity that is friendly regarding taxation and start up capital and change it to other forms as you gain firmer financial grounds. Or perhaps the opposite, the business needs time to establish itself first to attract investment in the future. Having a plan helps determine what structure will suit your business best to start.
Do I need a business license?
Yes. All legal businesses require a business license from Oregon. In addition, a business may require one or more professional or local business licenses. If your business operates across state lines or internationally it may require a license from each state or country in which it operates.