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doi: 10.1111/jsbm.12073
There is little work on how attorneys and accountants evaluate new small businesses when
giving advice. The focus of this paper is to gain a better understanding of those factors that are
important in the practice of advising small business owners on entity choice. We utilize a
policy-capturing methodology to study how attorneys and accountants evaluate the likelihood they
would advise a particular entity. Our results suggest that these two categories of advisers appear
to prefer different factors when determining the forma sole proprietorship, partnership, limited
liability companies, or S corporationsmall business should take.
Introduction
Small business owners face many legal and
accounting issues as they start their new business. In fact, the law touches all aspects of
management activity (Bagley 2008), and financial management for small firms can be complex
and confusing (Ang 2000; Jennings 2010). A
successful business will encounter legal issues
in areas such as business entity formation,
contracts, human relations, landlord/tenant relations, real estate, financing, and the environment (Barclift 2008). Accounting issues include
taxation, payroll, depreciation, cost management, and accounting methods for start-up costs
(Ang 2000; Holtzman 2004).
Recent work (Dyer and Ross 2007; Marcum
and Blair 2011; Scott and Irwin 2009) suggests
that seeking professional advice is an important
early step in creating a new business. Robson
and Bennett (2000) found evidence that small
and medium-sized enterprises that sought
professional advice had greater firm performance. The advice given by third parties, particularly professionals, can have a very strong
influence on the future of the business
(Marcum and Blair 2011). Issues with legal
implications require time to deliberate and a
specialized body of knowledge that most small
business owners do not have (Goossen 2004).
Owners of start-ups often opt not to incur the
legal and accounting fees and other similar
costs of fully assessing and allocating the
burden of potential risks, thus potentially
leading to the failure of the start-up (Fried
2005). Although scholars encourage small business owners to seek advice (Dyer and Ross
2007; Fried 2005; Holtzman 2004), limited work
has been done on how professionals advise
their clients.
A new venture is often complex, with factors
that may be unique to that venture. An adviser
must look at these complexities and relatively
quickly determine what advice he or she will
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business entity formation, use a policycapturing methodologya common methodology in SJTto measure the consistency of
evaluations across entity forms and relative
strength of the factors importance in the evaluation, and finally, describe potential implications as well as future research opportunities.
Entity Choice
Business entities choices to be considered
for the small business client can include sole
proprietorships, partnerships and limited partnerships, limited liability companies (LLCs),
S corporations, and corporations (Blair,
Marcum, and Fry 2010). Summary information
about these different entities can be found in
Table 1. Significant literature exists regarding
the entity selection factors from the perspective of the small business owner (Ribstein and
Kobayashi 2001), including taxation issues
and ease of formation. However, little is
known about the factors professionals use
when they advise.
Significant Factors in Entity Advice
Although attorneys and accountants may
perceive that they use numerous factors when
determining the best advice on entity formation, research in SJT suggests that individuals
use only a few factors when evaluating a specific scenario (Hitt and Tyler 1991; Zacharakis
and Meyer 1998). This suggests that there are a
small number of key factors that professionals
actually use.
To assist us in determining what factors
might be important for professionals, we interviewed 12 professionals in law and accounting
as to what factors they stated were important in
the evaluation. Some of the comments showed
clear espoused theories. For example, one
attorney stated this:
Heres my approach. Risk is the most
critical element of all. If significant perceived risk exists, proprietorships and
Table 1
Description of Business Entity Forms
Entity
Definition
Sole Proprietorship
Individual in business
for self
General Partnership
Limited Partnership
Limited Liability
Company
Members
S Corporation
Corporation
Advantages
Disadvantages
Ease of formation,
centralized
management, no
taxation
Partners agree to
management rules,
taxation to
partners, ease of
transferability of
partnership interest
Limited partners have
limited liability,
partnership
agreement
Limited liability of
each member,
management by
agreement, ease of
formation at state
level
Pass-through taxation
to owners, limited
liability of owners
Legal entity,
unlimited life,
centralized
management,
corporation is
financially liable
Must meet
requirements of
state statutes,
general partners
are financially
liable; limited
partners cannot
make daily
decisions
Members pay
self-employment
taxes, may be
harder to raise
money from
investors
Must follow IRS Code
for compliance, can
have only a limited
number of owners
Triple taxation
(corporate,
employee,
shareholders)
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252
small business venture. Some forms of business entities limit the number of owners that
a business can have (Mann et al. 2004). We
argue that S corporations and LLCs provide an
ease of transferability of ownership, whereas
sole proprietorships cannot have more than
one owner, and partnerships require a new
partnership agreement for a change in
ownership.
H2a: Attorneys and accountants will be more
likely to advise small business owners to
form their ventures as an S corporation
when there are multiple owners in the
business.
H2b: Attorneys and accountants will be more
likely to advise small business owners to
form their ventures as an LLC when there
are multiple owners in the business.
H2c: Attorneys and accountants will be less
likely to advise small business owners to
form their ventures as a sole proprietorship
or partnership when there are multiple
owners in the business.
Start-Up Costs. A third important factor in the
entity organizational selection process is the
costs associated with the start-up of the business. Transactional costs, such as state filing
fees, licenses, legal fees, and accounting fees,
as well as overhead expenses, such as insurance, rent, production, utilities, and intellectual
property, are important expenses in starting a
business (Mann et al. 2004). Costs differ considerably for different types of business ventures. High costs also suggest a more complex
business and one that might need external
financing (Scott and Irwin 2009), which will
likely be better handled with an S corporation
or LLC. A lesser need for capital might allow for
a simpler business entity, such as a sole proprietorship or partnership.
H3a: Attorneys and accountants will be more
likely to advise small business owners to
form their ventures as S corporations when
there are higher start-up costs in the
businesses.
H3b: Attorneys and accountants will be more
likely to advise small business owners to
form their ventures as LLCs when there are
higher start-up costs in the businesses.
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Methodology
Study 1: Attorneys
Participants. An
online
policy-capturing
instrument, a common methodology used in
SJT research, was sent to members of several
Midwest county and state bar associations
requesting assistance from attorneys who
advise small business clients on business entity
formation. From this, 24 participants completed
sufficient amounts of the instrument to be
included in our analysis. Aiman-Smith, Scullen,
and Barr (2002) argue that smaller samples are
appropriate for policy-capturing studies where
there is likelihood that the series of judgments
made by a participant will be consistent with
one another, and the importance lies in the
number of scenarios for the participants
(Karren and Barringer 2002). Our participants
completed a total of n = 378 evaluations for
each of our three dependent variables. Of those
that reported their gender, 81.1 percent
(n = 18) were men. The average years practicing law was 23.5 (standard deviation
[S.D.] = 12.7) and ranged 446 years. The
average number of clients that were advised
each year was 13.45 (S.D. = 11.3).
Instrument Design. Based on our research
questions, a policy-capturing approach was
used. In this regression-based methodological
approach, participants were given a series of
scenarios to help evaluate which factors are
relevant to the participant when evaluating the
scenario. Each scenario had different decision
factors, the levels of which vary across the
scenarios.
Four factors were developed based on existing literature on attorney advice to small business owners reviewed earlier in this paper. The
descriptions of each factor given to the participants can be found in Table 2.
Each factor varied on two cues. For the level
of owners, one cue was single and the other
was multiple. For the other factors, cues were
Table 2
Description of Each Factor as Described to the Participants
Factor
Description
bined into one dependent variable as multiple owners scenarios were meaningless for
sole proprietorships. However, sole proprietorships and partnerships have many similar
advantages and disadvantages, including
issues of risk potential, taxation, and complexity. For each scenario, participants were
requested to rate the likelihood that they
would advise a small business owner to
choose that particular entity form. Participants
could evaluate each form on a seven-point
Likert scale, with 1 labeled as very
unlikely to 7, labeled very likely. A
typical scenario is seen in Figure 1.
Participants were also asked questions
related to their demographic and educational
backgrounds.
Study 2: Accountants
Participants. Similar to Study 1, we sent an
online policy-capturing instrument to a large
accounting organization in the Midwest. Of the
participants who accessed the instrument, 66
completed enough data to be included in the
analysis. Of those participants who stated
gender, 35.3 percent (n = 24) were men. The
average number of years practicing accounting
was 27.1 years (S.D. = 12.0) and ranged 546
255
Figure 1
Sample Policy-Capturing Scenario for Attorneys
256
257
5.152**
0.140*
0.015**
0.048
0.009
0.058
0.009*
0.260**
0.010*
Coefficient
0.24
0.06
0.00
0.06
0.00
0.06
0.00
0.06
0.00
SE
S Corporation
22.70
2.37
3.13
0.81
1.89
0.99
1.96
4.42
2.07
t
5.282**
0.328**
0.000
0.230**
0.004
0.251**
0.004
0.018
0.005
Coefficient
0.27
0.06
0.00
0.06
0.00
0.06
0.00
0.06
0.00
SE
LLC
*p < .05.
**p < .01.
Hierarchical Linear Modeling, HLM; LLC, limited liability companies; SE, standard error.
Intercept
Liability
Years Practicing Law
Number of Owners
Years Practicing Law
Start-Up Costs
Years Practicing Law
Sophistication of Owner
Years Practicing Law
Factor
19.43
5.72
0.05
4.01
0.76
4.38
0.83
0.31
0.97
1.908**
0.494**
0.005
0.175**
0.002
0.133*
0.006
0.111*
0.002
Coefficient
0.20
0.06
0.00
0.06
0.00
0.06
0.00
0.11
0.00
SE
9.40
8.80
1.12
3.11
0.46
2.37
1.42
1.98
0.51
Sole Proprietorship/Partnership
Table 3
HLM Estimation of Cross-Level Effects of Factors in Evaluating Business Entity Advice: Attorneys
and partnerships ( = 0.494, p < .01), supporting H1ac. Participants were asked to describe
the typical types of firms with low or high risk
that they might see in these scenarios. Answers
for low-liability firms were most commonly
considered retail stores and also included momand-pop stores, service firms, consulting firms,
and firms in industries with low regulation.
Participants considered high-risk firms to
include manufacturing, medicine, food service,
and those with new inventions.
Number of Owners (Single versus Multiple). Multiple owners as a factor was not
found to be significantly related to a greater
likelihood to advise for S corporations
( = 0.048, ns), showing no support for H2a but
was found to be positively related to a greater
likelihood to advise for LLCs ( = 0.230,
p < .01), providing support for H2b. It was
found to be negatively related to the a likelihood to advise for sole proprietorship and partnerships ( = 0.175, p < .01), suggesting that
scenarios with multiple owners listed were
evaluated lower, supporting H2c.
Amount of Start-Up Capital (Low versus
High). The anticipated level of start-up costs
for the business was found to have no relationship for advising for S corporations ( = 0.058,
ns), suggesting no support for H3a but positively related to the likelihood to advise for
LLCs ( = 0.251, p < .01), supporting H3b, and
negatively related to sole proprietorship and
partnerships ( = 0.133, p < .05), supporting
H3c. When asked what was a typical amount of
low start-up costs, participants responded
between $0 and $250,000 with a mean start-up
amount of $30,075 (S.D. = 58,188). For high
start-up costs, participants responded with
dollar values from $1,000 to $1 million, with a
mean amount of $311,400 (S.D. = 388,725).
Sophistication
of
Owner
(Low
versus
High). The greater the perceived ability for
the small business owner to handle the paperwork and requirements of the entity was positively related to the likelihood to advise to form
as an S corporation ( = 0.260, p < .01), supporting H4a, but not for an LLC ( = 0.018, ns),
thus providing no support for H4b. It was negatively related to the likelihood of advising a
sole proprietorship or partnership ( = 0.111,
p < .05), supporting H4c. Typical responses to
low sophistication characteristics included
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Study 2: Accountants
The average evaluation from accountants on
the likelihood to advise a small business owner
to form their business (with seven as highly
likely) as an LLC ( = 5.000, p < .01) was higher
than their average evaluation of advising an S
corporation ( = 4.663, p < .01), both of which
were higher than the average likelihood to form
as a sole proprietorship or general partnership
( = 3.618, p < .01). Similar to Tables 3 and 4, it
includes the summary statistics for the crosslevel analyses for each dependent variable.
The four factors were analyzed to examine
their impact on the overall evaluation accountants used for determining the likelihood they
would advise for each business entity.
Potential Risk (Low versus High). The
expected level of liability of the business
was found to have no relation to a greater
likelihood to advise for S corporations
( = 0.063, ns) or sole proprietorship or partnership ( = 0.150, ns), thus not supporting
H1a or H1c, but positively related to advising
for LLCs ( = 0.210, p < .01), giving support for
H1b. Participants were asked to describe the
typical types of firms with low or high liability
that they might see in these scenarios. Answers
for low liability-type firms were similar to those
of attorneys and included retail shops, officetype service business, farms, internet sales of
goods, and those who can cover their liability
with insurance. Answers for likely types of
high-liability firms included medical establishments, ventures with large numbers of customers, construction, and trucking.
Number of Owners (Single versus Multiple). The multiple owners was found to be
positively related to a greater likelihood to
advise for S corporations ( = 0.238, p < .01)
and LLCs ( = 0.321, p < .01), suggesting that
scenarios with multiple owners would be more
likely to be advised to form as an S corporation
or LLC and providing support for H2a and H2b.
This factor was found to be negatively related
to the likelihood to advise for sole proprietorships and partnerships ( = 0.402, p < .01),
suggesting that scenarios with multiple owners
listed were evaluated lower, supporting H2c.
Amount of Start-Up Capital (Low versus
High). The amount of start-up capital needed
for the business was found to have a positive
relationship for advising for S corporations
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260
Coefficient
0.18
0.07
0.01
0.07
0.01
0.07
0.01
0.07
0.01
SE
S Corporation
25.93
0.89
0.11
3.35
0.70
2.03
0.04
1.90
0.63
t
5.000**
0.210**
0.004
0.321**
0.003
0.031
0.004
0.314**
0.02
Coefficient
0.15
0.07
0.01
0.07
0.01
0.07
0.01
0.07
0.01
SE
LLC
*p < .05.
**p < .01.
Hierarchical Linear Modeling (HLM); LLC, limited liability companies; SE, standard error.
Intercept
Liability
Years Practicing Accounting
Number of Owners
Years Practicing Accounting
Start-Up Costs
Years Practicing Accounting
Appreciable Assets
Years Practicing Accounting
Factor
34.11
2.83
0.74
4.37
0.50
0.42
0.74
4.33
0.41
3.618**
0.150
0.009
0.402**
0.006
0.058
0.002
0.222**
0.012
Coefficient
0.17
0.08
0.01
0.08
0.01
0.08
0.01
0.08
0.01
SE
21.91
1.82
1.26
4.93
0.86
0.72
0.23
2.75
1.81
Sole Proprietorship/Partnership
Table 4
HLM Estimation of Cross-Level Effects of Factors in Evaluating Business
Entity Advice: Accountants
Not Supported
Supported
Not Supported
Supported
Supported
Supported
Not Supported
Supported
Not Supported
Not Supported
Supported
Supported
Not Supported
Supported
Supported
Supported
Supported
Supported
Not Supported
Not Supported
Supported
H1
H2
H3
H4
H5
H6
Supported
Supported
Supported
Not Supported
Not Supported
Sole/Partnerc
LLCb
S Corporationa
Dependent
Variable
LLCb
Sole/Partnerc
S Corporationa
Study 2: Accountants
Study 1: Attorneys
Hypothesis
Table 5
Support for Hypotheses across Three Dependent Variables and Two Studies
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Conclusions
Despite the limitations addressed in the preceding section, this study suggests that advisers
examine a number of factors when advising on
entity formation and that these factors vary in
importance depending on which entity the professional is evaluating for the particular business and the small business owner seeking the
advice. Attorneys and other professionals who
provide assistance to small business will be
better able to identify the relevant factors and
provide superior services and education to
small business clients by applying the results of
this study. Gaining an understanding of these
factors can also assist small business owners
when they prepare to meet with these advisers
and help them to evaluate the advice of these
two professionals.
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