Business Law

If you are planning to start a new business or expand an existing business, your first consideration is often the appropriate choice of legal form. There are a number of choices under Michigan law that each provide different advantages and disadvantages. The form of business you choose should not only suit the industry you're in but also the individuals involved.

Generally speaking there are four basic corporate forms for businesses in Michigan:

The Sole Proprietorship: This is the most basic and fundamental business organization and the form of many if not most small businesses in Michigan. If you started a business but never sought a formal legal structure through the State of Michigan, you are a Sole Proprietorship. Sole Proprietorships often operate under trade names that may simply be registered with the County in which they are doing business. However, obtaining the trade name itself does not create a legal entity separate from the owner nor does not provide any protection for the owner from personal liability for corporate debts.

The Sole Proprietorship is a popular business form due to its simplicity, ease of setup, and nominal costs. Often no formalities are required other than getting a license from the local municipality and registering the name. The sole proprietor usually signs contracts and holds the business bank accounts in his or her own name. Also, because a Sole Proprietorship is not a separate legal entity from its owner, taxation is quite simple. The income earned by a Sole Proprietorship is income earned by its owner.

While simplicity and low cost make the Sole Proprietorship an attractive option, there is one very significant drawback. A sole proprietor is personally responsible for the debts of the business. Any debt owed by the business is a debt owed personally by the owner. One can easily imagine a catastrophic scenario in which a customer is badly injured or killed on the business premises potentially subjecting the sole proprietor to millions of dollars of personal liability not to mention significant legal costs.

The Partnership: Partnerships are similar to Sole Proprietorships except that they involve more than one person. A partnership is often simply defined as an association of two or more individuals to conduct, as co owners, a business for profit. Partnerships come in two basic forms: general partnerships and limited partnerships. The partners in a general partnership manage the company and assume personal liability for the partnership's debts and other obligations. A limited partnership is slightly different as it has both general and limited partners. The general partners in a limited partnership own and operate the business and assume liability for the partnership while the limited partners are passive partners having no control over the company. Limited partners, however, are not subject to the same liabilities as the general partners.

Much like the Sole Proprietorship, simplicity and low cost make the partnership form an attractive option. While a partnership can be formed by a simple oral agreement or even just the actions of the partners, it is advisable to get a formal partnership agreement drawn up that can assist with any disputes between the partners. One advantage of the partnership form is that generally the partnership itself does not pay taxes. Partnerships enjoy "pass through" taxation, similar to Sole Proprietorships, wherein each partner pays taxes on his or her share of the profits.

The biggest drawback of the Partnership form is that the general partners are personally responsible for the liabilities of the Partnership. This is an even bigger drawback than with the Sole Proprietorship because, in certain circumstances, a partner may bind his co-partners to a liability without their knowledge or tacit consent. Each general partner can act on behalf of the Partnership and make decisions that will bind all the partners. Further, each partner is also generally liable for the negligence of another partner and of the Partnerships' employees when the negligent act occurs in the normal course of business.

Limited Liability Companies (LLCs): Limited Liability Companies or LLCs are often thought of as half way between the Sole Proprietorship / Partnership and the Corporation. LLCs do have some formalities, such as filing yearly annual statements, but not the level of formalities required for Corporations. The initial setup requires making sure that the desired business name is available and then filing the articles of organization with the State of Michigan. It is also advisable to prepare a membership agreement for any LLC with two or more members. This agreement will set forth the basic understandings of the members and help resolve any future disputes.

One of the biggest advantages of the LLC form is its tax treatment. Unless it chooses to be treated otherwise, an LLC is not a separate tax entity like a Corporation, it is a pass through entity like a Sole Proprietorship or a Partnership. All of the profits and losses of the business pass through to the individual members. The LLC itself does not pay federal income taxes. Another one of the big advantages of the LLC form is the protection it provides the members Unlike Sole Proprietorships and Partnerships, the individual members of an LLC are generally not personally responsible for the debts of the business unless they agree otherwise.

The Corporation: The Corporate structure is more complex than other business structures with more formalities. A Corporation is an independent legal entity, separate from its owners requiring compliance with more regulations and tax requirements. The initial setup required verifying that the chosen name is available and then filing the articles of incorporation with the State of Michigan and preparing the shareholder agreement. The actual stock certificate showing how many shares an owner holds is also prepared. There are numerous other documents that are may be advisable in some circumstances such as a subscription agreement, a buy-sell agreement and/or a redemption agreement among others.

One of the benefits of a Corporation is the ability to raise money. Interest in the Corporation in the form of shares of stock can be sold to raise funds. Another benefit of the Corporation is the ability to retain earnings. Corporate profits can remain in the business without flowing to the owners as dividends for which the owners would then incur a tax liability.

The biggest downside to the Corporate structure is the cost. It is often the most expensive legal form because of the formality required both in terms of initial setup as well as ongoing operation. Another negative of the Corporation is the potential for double taxation. Not only are Corporations potentially subject to corporate income tax at both the federal and state levels, but any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal income tax returns.

When evaluating the varying choices of business formation, you need experienced legal counsel to advise you. Contact the Law Offices of Maynard F. Newman, PLLC at (810) 584-7068 to discuss which corporate form is right for you.