A business can be a legal entity. It may be totally your entity and responsibility, it may be shared with partners, or it could be a separate entity in which you and others own a share. When you wrote your business plan (Chapter 6) you may have decided which business structure you will take (sole proprietorship, partnership, and corporation). Following is a discussion of these forms to help you make the right decision for your business.

Sole Proprietorship

A proprietor is an owner. A sole proprietorship is a single owner. If you start a business by yourself you automatically are the sole proprietor; the majority of small businesses are sole proprietorships. It means that you are personally liable for all debts and commitments made by the business. It also means that your financial and credit resources are the only resources the business has available. It doesn't mean, however, that you must be the only employee. A large sole proprietorship can have hundreds of employees and numerous locations.

A sole proprietor has the greatest freedom of action, not requiring the permission of other owners or stockholders to make decisions. In addition, a sole proprietorship is the least expensive business entity to establish.

A major reason why businesspeople select one form of business over another is taxation. Sole proprietors pay income taxes on the profits, if any, of the business. If the store has $200,000 in annual sales and the store expenses (including inventory) are $150,000, the sole proprietor will be taxed for an income of $50,000.

Another reason to select a specific form of business is liability. Sole proprietors are liable for anything that their business does. That's why they buy insurance. However, if insurance doesn't cover major damage or a lawsuit, the proprietor must. Riskier enterprises can get more legal protection by establishing partnerships or corporations—at a cost.

Partnership

Need additional capital to start and run your retail store? Need some expertise and management help? Maybe a partnership is the best business form for you. A partnership is an entity wherein two or more people own a business. How they participate in the partnership depends on what type it is: general or limited.

A general partnership consists of two or more partners, each of whom has equal legal responsibility for the company's actions and debts. The partners don't have to contribute the same amount of capital or skill, and they aren't required to split profits evenly. General partners, typically, have unlimited liability, just as sole proprietors do. The details of capital and profits are included in the partnership agreement.

A limited partnership has at least one general (active) partner and one or more investors whose liability is limited to the amount of their financial contributions. If they invest $50,000 and the business somehow loses $200,000, the limited partner only loses the $50,000 while the general partner loses the rest. However, in most partnership agreements, the limited partner has no power in the day-to-day operations of the business.

The way in which partnerships are taxed is based on the partnership agreement. If it is an equal general partnership, the year's profits are split evenly and each partner must pay taxes on the amount received. In a limited partnership, the partners are taxed based on their share. If a limited partner receives 25 percent of profits, that is the amount the partner must pay taxes on, not on the entire profit of the business.

An Agreement of General Partnership includes the name and place of business, purpose of the business, and term (length of the partnership agreement). It also identifies the general partners, states how profits and losses will be distributed, notes how partnership interests can be assigned to others (if at all), and lists the rights and responsibilities of the general partners. In addition, there are terms that specify what will happen at the death or retirement of a general partner, as well as how the partnership can be terminated. Drawn up by a business attorney, a partnership agreement is a binding contract that will guide your business decisions.

Corporation

One of the disadvantages of both sole proprietorships and general partnerships is the owner's liability for business debts. If the business loses a $1,000,000 suit, the owners must pay it out of their own pocket (or insurance coverage). A corporation is different. A corporation is a legal entity that can buy, sell, and enter into contracts as if it were a person. It is responsible for its own debts, theoretically freeing the owners from this obligation. Practically, many smaller corporations are required to have primary stockholders cosign for major debts, minimizing the risk to lenders if the corporation fails. Legal advice is necessary in setting up a business corporation.

There are many types of corporations, including public (stock is sold to the public), nonprofit (actually, not-for-profit), and S corporation. Most large corporations pay income tax on profits; stockholders then must pay taxes on their share of profits—double taxation. An S corporation is a smaller corporation structure with a limited number of stock owners. It does not pay income tax on profits. Instead, it passes all profits on to owners, who must pay taxes as individuals. Which form is right for you in your unique situation? Ask a business attorney.

Corporations, even S corporations, can be expensive to launch because of all the legal advice and paperwork required. Make sure that your retail store requires the advantages and can accept the disadvantages of corporate structure before filing.

LLP

A newer option when setting up a business entity is the limited-liability partnership (LLP). It combines some advantages of partnerships and of corporations into a single entity. An LLP limits the liability of partners to the amount of their investment. Partners are not limited in their participation in business decisions. This structure is set up primarily for professional groups such as doctors, attorneys, and so on. Your state may or may not allow LLP ownership of retail stores. Some states allow limited-liability companies (LLCs). Check with your state's department of corporations for specific information.