Sole Proprietorship

The simplest form of business ownership is the sole proprietorship, comprised of one individual or a married couple. There is no legal separation between the owner and the business. The sole proprietor has full managerial control of business operations and does not share business profits or losses. There are no formal business formation requirements and no state business filings are necessary to commence operation as a sole proprietor. Startup and operating costs are minimal and business affairs are relatively easy to manage. Yet, the sole proprietor has no separate legal entity to shield him or her from personal liability for the debts and obligations of the business. Insurance can help offset the risk of personal liability for business acts and obligations; however, insurance cannot provide the same protection from third-party claims as a separate legal entity.

Most business experts agree that generally, the disadvantages of sole proprietorship far outweigh the advantages. As sole owner, you may face difficulties in raising funds or finding and maintaining qualified employees. But the chief disadvantage is unlimited personal liability. As sole owner, both your business and personal assets can be jeopardized in the event of a lawsuit initiated against your company.

The best option for the majority of business owners is to conduct business through a business entity that will limit personal liability for the company’s acts, debts and obligations. Let’s take a brief look at some options, keeping in mind that the tax implications of entity formation are not covered in detail in this article and should be evaluated carefully when determining which entity is most appropriate for your business.

Partnership

There are two primary types of partnerships in California, a general partnership and a limited partnership. A third type of partnership, the limited liability partnership is reserved for certain professional services.

General Partnership
In a general partnership, all general partners equally share profits and losses and assume unlimited personal liability for the debts and liabilities of the partnership. In California, no formal state filings are required to form a general partnership. Although a written partnership agreement is not required, it is advisable. The unlimited personal liability feature of the general partnership commonly makes it an unattractive option for most businesses. There are usually better entity choice options which eliminate the unlimited personal liability characteristic of the general partnership and preserve the beneficial “flow through” tax structure.

Limited Partnership
A limited partnership is created in California by filing a Certificate of Limited Partnership with the Secretary of State. As mentioned above, one of the benefits of a partnership is that it is a “flow through” entity, meaning that the partnership itself does not pay tax, rather the profits and losses of the partnership flow through to the individual partners who pay tax on their distributive share. A limited partnership is required to pay a minimum franchise fee of $800 but does not owe state tax. The primary benefit of a limited partnership over a general partnership is that at least one or more limited partners receive limited liability protection, meaning the limited partner’s liability is limited to the amount of their capital investment in the limited partnership. Although limited partners are not active participants in management of the business, limited partners do share proportionately in the profits or losses of the business.

Limited Liability Partnership (LLP)
A limited liability partnership (LLP) is a “flow through” entity which seemingly combines all the merits of the general partnership (active management authority for all partners) with the benefits of limited partnership (limited liability protection for all partners). However, in California the LLP is restricted to persons licensed to practice in the fields of public accountancy, law, or architecture.

Corporation

A corporation is an entity formed under state law that is a separate legal entity owned by shareholders. Corporations are the most popular way to organize a business, and for some valid reasons. In addition to limited liability for the owners of the corporation, corporations provide certainty in management and ownership structure and the opportunity to issue stock that can be transferred with ease.

You may be surprised to learn that incorporation is not quite as simple as filing legal documents with the Secretary of State. Corporations also must keep excellent records, hold regular meetings of board of directors and shareholders, and follow stringent formalities required by state law. If your business is not properly incorporated and maintained, you may be subject to personal liability for the debts and obligations of the business and lose the main advantage of corporate formation.

There are two main types of corporations – Subchapter S and Subchapter C – that are distinguished primarily through tax considerations. The majority of large and publicly held businesses are C-corporations. They are faced with the prospect of paying what is known as double taxation if dividends are paid. That is, corporations pay tax on any and all profits before dividends are paid to shareholders. Then, on the shareholders’ individual returns, taxes must be paid yet again.

A Subchapter S-corporation can eliminate the onerous double taxation characteristic of the C-corporation when the corporation elects to be taxed as a partnership. This provides the “flow through” tax benefit of the partnership structure to S-corporation shareholders, who additionally receive the limited liability protection benefit of the corporate form. However, an S-corporation is limited by the types of owners, which may not exceed 100 shareholders.

Whether you select a C-corporation or make the S-election, your corporation must create bylaws, a governing document including items such as shareholder meetings, director meetings, and number of officers and their responsibilities. A separate bank account and separate business records are required. Both types of corporations must pay an annual $800 minimum franchise fee, although an S corporation does not pay federal income tax.

Limited Liability Company (LLC)
The LLC combines the “flow through” tax structure and managerial flexibility of a partnership with the limited liability protection for owners offered by a corporate entity. While the members of an LLC are not required to create a written operating agreement, it is advisable. However, there are no annual shareholder or board meetings as required with the corporation. In fact, an LLC has no board of directors or officers, and the day to day management of operations may be done either by all members of the LLC or a manager elected by the members of the LLC.

Furthermore, the flexible management structure and the limited personal liability benefit for owners of the LLC provide legal advantages to owners of real property who hold title in the form of an LLC. Any person owning income property should evaluate whether an LLC is right for them.

Making The Right Decision
This brief overview is an introduction to your business entity choices and the factors to consider. You should further investigate your options, particularly the tax considerations involved. While entity selection is only one consideration in the pursuit of a successful business venture, your decisions can have profound implications for your success or failure.

A qualified business attorney can help you weigh your options and make the proper choice for your prospective business. At the Kabak Law Group, we are experienced in business entity formation and related transactions.

Contact us today for an initial consultation and let us help you succeed.

When buying or selling a business, your primary goal is to maximize your return on investment. However, a business purchase or sale is a complex transaction and planning the terms of the deal beyond price is important. Financing, tax consequences and commercial lease terms are essential to the success of your business transaction. Let’s investigate these three elements below.

Financing the purchase of a business

A bank loan and/or personal savings are commonly used to finance a business purchase. However, a loan from a bank can be difficult to obtain, particularly in the current economic environment, and using personal assets for a business purchase is a great risk. Another option, beneficial to both buyer and seller, is seller financing.

Here’s how it works. Let’s assume a business is for sale for $200,000. With seller financing, the buyer could pay $100,000 cash, and sign a promissory note for the balance of the purchase price, to be paid off over five years. The note would require monthly principal plus interest payments to seller. The advantage to the buyer is that he/she is not required to apply for and qualify for a bank loan and is able to fund the purchase from business revenues. The seller benefits by receiving a higher price, earning interest on the note and expediting the closing without bank approval.

Seller financing is not for everyone. Why? The buyer and seller remain in a long-term relationship until the loan is repaid. The seller also continues to have a financial and emotional stake in the successful performance of the business. This type of financing works best when there is a strong likelihood of quick or continued business success for the new owner. Seller financing then becomes a very useful and attractive method of financing.

Taxes and the role of the Certified Public Accountant in a business sale

When a business is sold for profit, seller earns income and the attention of the IRS. Income derived from the sale of a business is classified as either ordinary income or capital gain. Ordinary income is taxed at a higher rate than capital gain. The structure of your company and the classification of the assets sold determine whether the income is considered ordinary income or capital gain for tax purposes.

As the seller, you can negotiate terms that provide tax advantages if you plan well and execute your strategy. Your CPA working closely with your business attorney can help you structure your business sale in the most advantageous way possible to maximize your rewards and avoid critical mistakes.

The importance of a valid lease assignment when buying a business

It is essential that a buyer of an existing business negotiate for and obtain a valid lease assignment from the seller. This most often will require the landlord’s written consent after landlord’s review of the buyer’s financial information.

An assignment of lease is a transfer of all obligations under an existing lease to a third party. In the context of a business sale, the original commercial tenant assigns the remainder of the lease term, duties and obligations to the buyer of the business who becomes the new tenant. However, the original tenant still remains liable in the event of a default by the new tenant, unless released from liability by the landlord.

As a buyer of an existing business, it is vital to understand all material terms of the commercial lease prior to closing the purchase, the requirements for a valid lease assignment and obtain the landlord’s written consent to assume the lease.

To prevent the devastating financial consequences of improper lease assignment and to learn how we can help you successfully structure your business sale or purchase, please call us for a business planning session.

The signs of innovation, creativity and optimism abound. While we face continued challenges, the San Francisco Bay Area is ripe with economic opportunities. The trends speak for themselves: residential rent in San Francisco is escalating, eighteen local firms are in the IPO queue, shared work space for tech entrepreneurs in SOMA is on the rise, and the lavish company party is back. It’s worth recognizing that it is thrilling to live and work in this unique culture which rewards entrepreneurship and creates opportunities for all.

By now, the Silicon Valley start-up is legend and San Francisco Bay Area entrepreneurs in fact have changed the way industries operate and business is done the world over. News articles, analysis, and even Hollywood productions tell the tale of the Silicon Valley tech entrepreneur, the youthful risk taker striving to become the next big thing or even cash in on a “me too company”. Despite these iconic images of our local business culture, you don’t have to be a twenty something engineer to be a successful entrepreneur. Entrepreneurs and innovators span all industries, age groups and backgrounds. The benefits of starting or buying a business can be yours too.

There are plenty of very good reasons to own a business. We live in a culture that encourages entrepreneurship, in fact, rewards it. Starting a business has never been easier as technology has enabled small businesses to compete cost effectively and advertise efficiently. I agree with many of my most successful clients, colleagues, and friends, that there is no greater thrill in business life than to put yourself out there with your name on it. While the news headlines frequently focus on big business, the engine of economic growth is entrepreneurship and small companies have proven a reliable source of new jobs. Understanding the risks is important, but if you think it may be right for you, you owe it to yourself to explore your options.

I hope you find the two articles on entity choice and buying or selling a business helpful and that you enjoy our newsletter focused on issues of importance and concern to the small business owner and entrepreneur.

Best regards,

Matt

580 California Street, Suite 1600, San Francisco, CA 94104
tel 415.283.3312 | fax 415.283.3315 | www.kabaklaw.com