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Journal of Small Business Management 2015 53(1), pp.

249265
doi: 10.1111/jsbm.12073

Heed Our Advice: Exploring How Professionals Guide


Small Business Owners in Start-Up Entity Choice
by Eden S. Blair and Tanya M. Marcum

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

Eden S. Blair is an Assistant Professor of Entrepreneurship at Entrepreneurship, Technology and Law,


Foster College of Business, Bradley University.
Tanya M. Marcum is Associate Professor of Business Law at Entrepreneurship, Technology and Law,
Bradley University.
Address correspondence to: Eden S. Blair, Entrepreneurship, Technology and Law, Foster College of
Business, Bradley University, 1501 Bradley Avenue, Peoria, IL 61625. E-mail: esblair@bradley.edu.

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249

give the small business owner. This paper will


use a Social Judgment Theory (SJT) (Brunswik
1956; Joyce and Brehmer 1988) framework to
evaluate the factors used by advisers when
evaluating the business entity advice they
might choose to give to a small business owner.
SJT states that experts use cues from multiple
uncertain pieces of information to determine
the best judgment of the correct outcome.
Research in SJT often finds that, although
experts will state multiple factors that they used
to evaluate a situation (an espoused theory),
experts lack insight into the factors they actually use when making decisions (Reilly and
Doherty 1989; Zacharakis and Meyer 1998).
Although advisers may state that they follow
professional guidelines, as to the appropriate
way to advise a client, their actual practice
might differ. This SJT framework and its findings suggest two important research questions
that we propose to answer in this paper. First,
what factors might be significant to advisers
when evaluating new ventures? Second, do
advisers use factors that are consistent with
literature in their respective fields?
To examine these questions, we have
chosen the scenario where the owners of a
new venture seek separately the advice of an
attorney and an accountant to determine the
business entity form the small business should
select. We argue that this scenario is appropriate for this study because the optimal time to
seek professional advice for the small business
owner is often in the entity formation stage
(Schanz 2007). Out of all the legal decisions to
be made regarding the organizational structure
of the ventureagreements between founders
and owners, financing, contracts, risk management, intellectual property, management and
control of business entities, ease of transferring interests, and labor relations (Mann,
OSullivan, Robbins, and Roberts 2004; Schanz
2007)one of the most common legal issues
in this phase is entity formation (Malach, Robinson, and Radcliffe 2006). Selecting the best
entity for the particular small business client is
a high priority (Mann et al. 2004), and small
business owners need to utilize their advisers
early in the start-up process to derive the best
benefits (Marcum and Blair 2011).
In this paper, we review the literature on SJT
as well as business entity formation, describe the
method in which we determined the factors of a
business that we believe might be important for
professionals to evaluate when giving advice on

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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.

Theory and Hypotheses


When providing a start-up advice to new
small business owners, many factors are important to the professional advisers. For this paper,
we will focus on attorneys and accountants,
although other advisers, such as insurance
agents, business consultants, and investors,
have a role in advising the small business
owner (Dyer and Ross 2007).

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

JOURNAL OF SMALL BUSINESS MANAGEMENT

Table 1
Description of Business Entity Forms
Entity

Definition

Sole Proprietorship

Individual in business
for self

General Partnership

Two or more enter into


a business with profit
motive

Limited Partnership

One general partner


who manages the
daily activities; limited
partners who invest

Limited Liability
Company

Members

S Corporation

Entity selection made


following IRS laws to
be treated as a
partnership for tax
and corporation for
liability
Creature of state statute
as a separate legal
entity business that
may be for profit or
not-for-profit

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

Full legal and


financial liability on
one

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

Complex state laws,


partners are
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)

IRS, Internal Revenue Service.


partnerships are seriously discouraged.
The differences in startup costs between
LLCs and S or C Corps is negligible in
light of other startup costs, and therefore
not a significant factor in my advice.
Another attorney stated in the business organization formation:

I stress that the LLC form appears best


for members who are limited in numbers
(no shares or trading on the market) but
who desire limited liability and protection from risks of losing investment, who
can enjoy reduced start-up costs and
who may be unsophisticated (possibly
new and young entrepreneurs).

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This provides evidence of a clear strategy,


which a hierarchy of factors that is examined,
with one factor a greater priority. After these
interviews, 15 relevant factors in entity advice
were identified. These 15 factors were longterm goals, number of employees, tax consequences, owners financial situation, potential
liability of risk for the business, start-up costs,
amount of start-up capital raised, expectation
for a long-term relationship with client, type of
goods/services sold, number of owners,
number of external investors in the business,
location of the business, complexity of the
paperwork needed for the business, the ease of
transferability of ownership, and annual reporting requirements. After these were identified,
the authors, with the assistance of two attorneys and an accountant with experience in the
field, analyzed for overlapping constructs in the
factors, as well as compared the factors with
relevant literature in law, accounting, and small
business. From this, six relevant factors
emerged: risk potential, number of owners,
start-up costs, complexity of paperwork,
sophistication of the small business owner, and
real estate and other appreciable assets.
These six factors were shown to seven attorneys and accountants to see if these factors
appeared to cover the most relevant cues of a
small business that the professional would use
to provide advice. The attorneys felt that the
complexity of paperwork factor could be
included within the factor of the sophistication
of the owner as a more sophisticated owner is
one that could be described as being able to
handle complex paperwork. The accountants
interviewed felt that real estate and other
appreciable assets were relevant, whereas the
sophistication of the owner was not; the attorneys felt the opposite. The factors are described
in more detail on the succeeding discussions.
Risk Potential. Risk potential, often referred
to as personal liability, is a significant factor in
the entity selection process. The evaluation of a
small business venture for potential legal risks
is an important responsibility for the lawyer
(Barclift 2008). Personal liability for the owners
for perceived risks should be minimized. In
addition, a careful assessment of insurance
requirements for the new business venture is
always necessary (Luppino 2004). Business
owners who form as a sole proprietorship or
general partnership have a high risk that their
personal assets will be lost if something hap-

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pened to the business, such as an injury to a


customer or lawsuit (Mann et al. 2004). Business entities such as an LLC or an S corporation
can protect their personal assets and only risk
the assets of the business or their personal
investment in the business (Blair, Marcum, and
Fry 2010).
The evaluation of a small business venture
for potential for legal risk appears to be an
important responsibility for a lawyer or attorney when advising on business entity formation
(Barclift 2008). Included in the risk analysis for
the professional is the type of business, the
business experience of individuals, the type of
business entity formation, and the insurability
of the venture. We argue that attorneys and
accountants will advise small business owners
with potentially large liability risks to form as
an S corporation or LLC to protect the owners
personal assets. However, not all businesses
have a high likelihood of risk potential and
may be able to form as a sole proprietorship or
general partnership. These simpler and less
expensive entities might be easier to manage
and reasonable for certain types of small businesses. These lead to the following hypotheses:
H1a: Attorneys and accountants will be more
likely to advise small business owners to
form their ventures as S corporations when
there are higher potential liability risks for
the businesses.
H1b: Attorneys and accountants will be more
likely to advise small business owners to
form their ventures as LLCs when there are
higher potential liability risks for the
businesses.
H1c: Attorneys and accountants will be less
likely to advise small business owners to
form their ventures as sole proprietorships or
partnerships when there are higher potential
liability risks for the businesses.
Number of Owners. Second, the number of
owners involved in the business venture
appears to be another important factor
(Ibrahim 2004). The more owners there are in
a business, the more complicated the issues
surrounding management and control of the
business, as well as increased financial risks
and the more cumbersome transfer of ownership (Jennings 2010). This factor includes all
individuals seeking ownership interests in the

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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.

H3c: Attorneys and accountants will be less


likely to advise small business owners to
form their ventures as sole proprietorships or
partnerships when there are higher start-up
costs in the businesses.
Sophistication Level of Owners. Lawyers also
consider the complexity of paperwork needed
to form a particular business form, as well as
compliance paperwork. Weighing the potential
financing options can be complex, and cumbersome paperwork may be necessary in order to
complete the transactions (Schanz 2007). Drafting complex legal documents such as employment contracts with employees, organizational
documents among the small business owners,
and contracts with suppliers and construction
companies is likely to need some additional
paperwork (Luppino 2004). Add to this the
day-to-day business recordkeeping, payroll,
periodic tax reporting, and tax planning; the
complexity grows (Luppino 2004). Understanding the complex requirements for certain business entities can be difficult for small business
owners, especially if they have lower levels of
education or business experience.
The need to understand complex paperwork leads to our final factor for attorneys: the
sophistication level of the small business
owners. If the business entity involves a great
deal of thought and planning and a detailed
operating agreement, the sophistication level
of the owners and their ability to follow
through will be important (Stover and Hamill
1998). Small business owners often have
limited sophistication as customers of professional services (Luppino 2004). Understanding
the fees for professionals, state filing fees,
permits, contracts, co-owner agreements, and
long-term state filing requirements for the
entity, requires, we believe, a more sophisticated small business owner. Characteristics of
sophistication include the ability to follow
through with necessary tasks, the past business experience of the owners, the education
of the owners, the ability of the owners to
listen to advice from professionals, and the
prior research conducted by the small business
owners prior to meeting with professionals.
LLCs and S corporations, with more complex
reporting requirements, will likely require a
more sophisticated small business owner; sole
proprietorships or partnerships may be better
suited for those who cannot manage complex
paperwork as well.

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253

H4a: Attorneys will be more likely to advise


small business owners to form their ventures
as S corporations when they perceive a
higher level of sophistication in the client.
H4b: Attorneys will be more likely to advise
small business owners to form their ventures
as LLCs when they perceive a higher level of
sophistication in the client.
H4c: Attorneys will be less likely to advise small
business owners to form their ventures as
sole proprietorships or partnerships when
they perceive a higher level of sophistication
in the client.
Real Estate and Other Appreciable Assets. In
our interviews with accountants, real estate and
other assets that can appreciate in value were
listed as an important factor for business entity
formation and thus included in our survey for
accountants as they generally are retained to
manage those complex items on behalf of their
client. This includes land, intellectual property,
and personal property in which the entity has an
interest. These assets can lead to complex taxation issues, which can be better managed with
an S corporation or LLC as the entity choice
recommendation.
H5a: Accountants will be more likely to advise
small business owners to form their ventures
as a S corporation when they perceive a
higher level of appreciable assets needed for
the business.
H5b: Accountants will be more likely to advise
small business owners to form their ventures
as LLCs when they perceive a higher
level of appreciable assets needed for the
business.
H5c: Accountants will be less likely to advise
small business owners to form their ventures
as sole proprietorships or partnerships when
they perceive a higher level of appreciable
assets needed for the business.
Years in Practice. LLCs and the statutes allowing for them are relatively new (Blair, Marcum,
and Fry 2010). Those attorneys and accountants
who are closer to having completed their law or
accounting degrees might view these entities
differently because of their more recent education than those who finished their professional

254

degrees prior to the enactment of these state


statutes.
H6: Those attorneys or accountants who have
more recently graduated from law school or
a certified public accountant (CPA)
program are more likely to advise small
business owners to form their ventures as
LLCs than those attorneys who graduated
earlier.

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

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Table 2
Description of Each Factor as Described to the Participants
Factor

Description

Potential Liability Risk


Number of Owners
Start-Up Costs

Sophistication Level of the


Client (Attorneys Only)

Purchase of Appreciable Real


Estate or Assets (Accountants Only)

Potential liability the client is exposed to. It includes


type of business, industry business experience of
individuals, insurance/insurability.
These include all individuals seeking ownership
interest in the business. Multiple owners, in this
case, mean more than one owner.
The overall start-up investment, taking into account all
costs related to operating the business (e.g., filing
fees, professional fees, equipment, website
development, real estate, rent, production, and
utilities)
Whether or not the client will appropriately handle the
requirements associated with the particular entity
chosen (e.g., filing annual reports, following through
with paperwork, dealing with complex paperwork,
and keeping meeting minutes)
The purchase of large assets that affect taxation

written as low or high without a specific


level (such as dollar value for start-up costs)
mentioned. Research did not demonstrate any
specific level in which these might be considered high or low, and perceptions of such may
vary across attorneys. The participants were
later asked to describe an appropriate level of
high and low for each factor to better understand their individual reference points, which is
discussed in greater detail in our analyses.
A full-factorial model was used. This meant
that each participant received all possible scenarios that can be achieved using all four
factors varying at two cues each (42 = 16). Scenarios were designed to provide information
quickly to the participant to reduce time
and fatigue (Aiman-Smith, Scullen, and Barr
2002).
Dependent Variables. Although other business entity forms exist, such as the C Corporation, a limited liability partnership, and the
low-profit limited liability company, we were
concerned with the types of business entity
forms most common for new small businesses
(Jennings 2010). These were the S corporation, the LLC, a sole proprietorship, and a
general partnership. The latter two were com-

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

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255

Figure 1
Sample Policy-Capturing Scenario for Attorneys

years. They advised on average 18.8 clients a


year (S.D. = 44.9). Of those that answered, 28
identified themselves as a CPA, 33 as an
enrolled agent, 25 as a nonenrolled tax professional, and one as an attorney, with some individuals selecting more than one role.
Additional Factor: Appreciable Assets. Three
of the factors (risk potential, number of
owners, and start-up costs) and the three
dependent variables remained the same.
Appreciable real estate and other assets were
described to the participants as the purchase of
a large asset that would have an impact on
taxation. This was rated as high or low.
Instrument Design. This study was very
similar to Study 1. However, there was a
concern from participants of the attorney study
that there were too many scenarios. A serious
concern in policy-capturing studies is fatigue,
and a balance is important between the number
of scenarios to get good results and the amount
of time it takes to complete each scenario
(Aiman-Smith, Scullen, and Barr 2002). This
may be especially true when the participants
are busy professionals who might be less
inclined to take time to complete an instrument. Based on the lower than anticipated
completion rate for our first study, we decided
to do a fractional design for Study 2. Participants randomly completed six to eight of the 16
scenarios. This allowed us to get more data
from more respondents (n = 434 evaluations
for each dependent variable).

256

Analysis and Results


Study 1: Attorneys
As it is reasonable to assume that the 16
responses for each subject for each variable are
not independent, we utilized Hierarchical
Linear Modeling (HLM) analysis (Raudenbush
and Bryk 2002), a hierarchical approach that
can estimate both within-subject (Level 1) and
between-subject (Level 2) variables (Hurt,
Maver, and Hofmann 1999). Table 3 includes
the summary statistics for the cross-level analyses for each dependent variable. The estimation
of the intercept represents the attorneys perception of the likelihood they would advise for
each business entity (on a 17 scale) across all
scenarios. On average, attorneys evaluated
their likelihood to advise a small business
owner to form their business as an LLC slightly
higher ( = 5.282, p < .01) than they would as
an S Corporation ( = 5.152, p < .01), both of
which were much higher than the average likelihood to form as a sole proprietorship or
general partnership ( = 1.908, p < .01).
Each of the factors used in the scenarios was
analyzed to examine its impact on the overall
evaluation for each of the three business entity
variables.
Potential Risk (Low versus High). The
expected level of potential risk of the business
was found to be positively related to a greater
likelihood to advise for S corporations
( = 0.140, p < .05) and LLCs ( = 0.328, p < .01)
and negatively related for sole proprietorships

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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

258

items such as owners with little education


and/or experience, blue collar backgrounds,
those with no business plan, or those with poor
record keeping skills. High sophistication characteristics included higher education and prior
business ownership experience, experience
with legal issues, and a willingness to learn.
Most Important Factor Stated. Participants
were asked to state the most important factor
that they used when making their decision.
Past research (Hitt and Tyler 1991; Zacharakis
and Meyer 1998) suggests that participants
lack insight into which factors they use. A
total of 43.3 percent (n = 13) of participants
stated that potential liability was the most
important factor, which our data suggest is
correct for advising for LLCs and sole proprietorships and partners. However, owner
sophistication was most important in advising
for an S corporation. The number of owners
was most important for 23.3 percent of our
participants, and 13.3 percent stated the
sophistication of owners was most important.
None stated that start-up costs were the most
important factor. As a manipulation check,
the participants were asked to rank order the
importance of our original 15 factors. The
most important factor they stated was potential risk, followed by tax consequences, and
then types of goods or services sold. However,
we argue that tax consequences are an antecedent of the selection of an entity, and the
types of goods or services are relevant in
assessing the potential risk factor. In fact, the
type of business was part of the description of
the risk factor to the participants.
Years Practicing Law. We also examined one
between-subject characteristicthe years the
participant has been practicing law. This variable was insignificant for all factors for the LLC
and sole proprietorship/partnership dependent
variables. However, we did find some support
for the relationship between years practicing
law and three factors when advising a small
business owner to form as an S corporation.
Those with more experience practicing law
were more likely to use potential liability
( = 0.015, p < .01) and start-up costs ( = 0.009,
p < .05) when making their evaluations, and
those with less experiences were more likely
to use sophistication of the owner when evaluating ( = 0.010, p < .05). This did not support
H6.

JOURNAL OF SMALL BUSINESS MANAGEMENT

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

( = 0.143, p < .05), supporting H3a, but not


related to the likelihood to advise for LLCs
( = 0.031, ns), demonstrating no support for
H3b. It was not related to sole proprietorships
and partnerships ( = 0.058, ns), not supporting H3c. When asked what was a typical
amount of low start-up costs, participants
responded between $0 and $100,000 with
a mean start-up amount of $8,949 (S.D. =
17,477). For high start-up costs, participants
responded with dollar values of $1,000
to $500,000 with a mean amount of $41,141
(S.D. = 82,848).
Purchase of Appreciable Real Estate and Other
Assets. High levels of appreciable assets were
not related to advising for S Corporations
( = 0.133, ns) but positively related to advising to form as an LLC ( = 0.314, p < .01), supporting H5a but not supporting H5a. High
levels of appreciable assets were negatively
related to advising to form as sole proprietorship or partnership ( = 0.222, p < .01), supporting H5c.
Most Important Factor Stated. Similar to attorneys, participants were asked to state the most
important factor that they used when making
their decision. Of the accountants that
answered, 79.4 percent (n = 50) of participants
stated that potential liability was the most
important factor, which our data suggest is
incorrect as the factor with the highest coefficients and t values is the number of owners,
with liability as an insignificant factor for both
S corporations and sole proprietorships/
partnerships. A total of 12.7 percent (n = 8)
stated that the number of owners was most
important, and 7.9 percent (n = 5) stated the
purchase of appreciable assets was most important. As with attorneys, none stated that start-up
costs were most important. Similar to the attorneys, the accountants were asked to rank order
the larger number of factors. Potential risk was
ranked first, number of owners second, and
owners financial situation was third.
Years Practicing Accounting. We also examined the between-subject characteristic of years
the participant has been a practicing accountant. This variable was insignificant for all
factors for all three dependent variables, giving
no additional support for H6. Results for each
hypothesis for both studies can be found in
Table 5.

BLAIR AND MARCUM

259

260

JOURNAL OF SMALL BUSINESS MANAGEMENT


4.663**
0.063
0.009
0.238**
0.004
0.143*
0.000
0.133
0.004

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

Discussion and Implications


The purpose of our study was twofold. First,
we attempted to determine which factors about
small business or its owner(s) were important
for advisers when determining their advice on
entity formation. For this, we developed multiple factors, which we narrowed to four for
both types of adviser in our study. All factors
chosen were supported for our samples for at
least one business entity. This suggests that
these factors may be important ones for the
advisers to examine when determining whether
they would advise at least one of the business
entity forms examined in this survey. For
example, based on our sample, sophistication
of owner may matter for S corporations but not
LLCs but should be examined before any advice
is given on any entity as it may rule out other
entity choices.
Our research partially supported our
hypotheses that liability was an important
factor for attorneys and accountants in our
sample when determining entity form.
Although S corporations and LLCs were created
primarily to assist small business owners with
the protection of their personal assets, for
accountants in our sample, this factor was only
a significant predictor of entity advice for LLCs
and was insignificant for S Corporations and
sole proprietorships/partnerships. The largest
effect sizes for accountants based on our analysis were with the factor number of owners. This
suggests that accountants are concerned more
with issues related to taxation rather than perceived liability of a particular type of business.
The attorney factor with the largest effect size
for advising for S corporations was the ability
of the owner to handle complex and sophisticated paperwork.
Second, we were interested in understanding the advisers consistency with their
espoused theories and guidelines from their
professions. Specifically, we were interested in
the relationship between the individual factors
and the entity advised by the professional. Our
results suggest four implications. First, attorneys and accountants in our sample are not
clear as to which factor is the most important
when advising on entity selection. Both professions had the majority of participants choosing
liability as the most important factor, but a
comparison of coefficients and t values suggests this is only true for attorneys when
advising for LLCs or sole proprietorships and

BLAIR AND MARCUM

261

partnerships and for accountants for LLCs.


Second, no factor was consistently used by
both accountants and attorneys to evaluate
their likelihood to advise for all business entities. This suggests that even for entities like S
corporations and LLCs, which are very similar,
subtle differences in the characteristics of the
small business owners and/or their venture can
affect the likelihood to advise one entity over
another. It is possible that a professional
prefers one entity over another for any situation, perhaps because they are more comfortable or have more experience with it. For
example, the professionals were asked an
open-ended question at the end of the survey
about the factors chosen. One stated,
Our office is less likely to promote LLC
as a startup choice because it is more
expensive to do, more complicated to
maintain, and basic incorporation gives
basic protection of personal assets . . .
with general liability insurance. If [the]
nature of business is clearly risky, and/or
multiple owners in a risky business are
sophisticated and working with good
accountants, then Id recommend LLC.
This is inconsistent with another who stated,
Today most clients like LLCs because of the
simpler record keeping and partnership tax
benefits. This suggests a different espoused
theory of an LLC. Third, small business owners
may get different advice on entity choice if they
seek assistance from both an attorney and an
accountant. This can lead to confusion about
which one to follow. Finally, attorneys consider
the characteristics of the small business owner,
not just the business, when advising their
clients.
Although four of the factorspotential risk,
number of owners, start-up costs, and appreciable assetsare mentioned in the literature
(Khandekar and Young 1985; Malach,
Robinson, and Radcliffe 2006; Schanz 2007),
the level of sophistication of the client is not
mentioned in the literature that lawyers are
likely to use to educate themselves on these
issues. This suggests they may be giving legal
advice based on the characteristics of the
owners, not their ventures. These lead to
quickly formed judgments that the attorney
made about the business owner which may
have long-term legal implications for the business. In addition to that, our data suggest these

262

professionals may make judgment calls about


the overall business based on a short interaction with the client, which may not give them a
full picture.

Implications for Practice


The structure of a business determines its
owners rights, responsibilities, and potential
for liabilities. Different business entities and the
structure of these entities afford varying levels
of flexibility for the operation of the business.
Understanding what factors are actually used
versus perceived as used by professionals when
advising their small business clients is important when making entity selection recommendations to their clients. If professionals
understand better what factors are actually
important to them in providing start-up advice,
their communication to their clients can be
more effective.
Professionals. When professionals are advising their small business clients, they are faced
with a plethora of legal and accounting issues
that must be addressed. It may be difficult for
professionals to understand the intuitive
decision-making process actually being used to
navigate the many legal and accounting issues
because of the vast amount of information
needed from their clients in a relatively short
period of time. With a better understanding of
the importance of individual factors, adjustments can be made by the professionals to the
analysis of these issues relative to entity formation advice. In addition, professionals may
want to have a clear checklist or set of guidelines based on the literature when helping a
client. This may make the process more consistent and faster. The checklist could look at
one factor at a time. For example, professionals
may want to determine the potential risk first,
which might exclude forms such as a sole proprietorship or partnership, then move to
number of owners, and so on, to reach the best
advice.
Differing opinions can lead to confusion for
the client. An attorney should be aware of what
an accountant may feel are important factors
given a particular new business venture and
that an accountant may recommend a particular
business entity choice. The attorney could then
provide a clear pathway to entity formation
selection to the client. Although the professionals may have a different factor or factors in
focus when advising the same particular client,

JOURNAL OF SMALL BUSINESS MANAGEMENT

it is important to come together for consistent


advice to the economic welfare of the client
(Degos 2009). It is possible that conflicting
advice to a client may be perceived by the
client as poor quality of advice (Dart 1995).
Small Business Owners. We argue that small
business owners need to understand the factors
that professionals deem as important in business entity determinations. As many new business owners are dealing with a myriad of tasks
at the stage they seek advice on business entity
formation, they might be unprepared for their
meeting with them, exhibit a lack of sophistication or clear details on the ventures true
characteristics and may be advised poorly
(Marcum and Blair 2011). We encourage small
business owners to take the time to obtain the
information that will assist their professionals
in making the best entity formation decision for
their particular small business. The small business owners may also be better prepared on the
likely types of entities that would be appropriate for their venture, thereby saving time and
money when meeting with these advisers.
Small business owners should be aware that
different factors are more important to different
types of professionals to whom they may seek
advice. Because different factors are more
important to attorneys than accountants, the
small business owner should realize that different advice may be provided to them from each
one. If an attorney and an accountant provide
different advice, it may prove prudent to
discuss the advice provided by one professional to the other professional. An awareness
of the factors used by other types of professionals will assist the business owners to then
make the ultimate entity formation decision
that takes all factors and advice into account.
As professionals advise their small business
clients, understanding the relative importance
of particular factors can save the clients time
and money. Small business owners usually
have a limited amount of financial resources
available to them, and there are many demands
for these monetary resources (Marcum and
Blair 2011). Information that is really not
important to the professional in the administration of start-up advice does not have to be
compiled by the small business owner, thus
saving the small business owner both time and
resources. This time can be better spent on
other important decisions. Clients will likely
believe that their professional is serving their

best interests. In addition, professionals can


understand that different factors are important
to different types of professionals and could
lead to client confusion. Confused clients may
choose to ignore advice altogether, ending in
the ultimate failure of the business.

Limitations and Future Research


Although we argue that this study gives
several important insights into how professionals advise their clients, we do know that there
are limitations to our work. First, we had relatively small numbers of participants, particularly in our attorney study, which may lead to
some generalizability issues. However, there is
some argument that even understanding how
one person evaluates scenarios can be useful;
sample sizes of fewer than 50 are common,
and the importance in policy-capturing studies
lies in the number of scenarios, not the
number of participants (Aiman-Smith, Scullen,
and Barr 2002; Karren and Barringer 2002).
Each participant made as many as 48 evaluations, giving us a total of 378 evaluations for
each dependent variable for attorneys and 434
evaluations for each dependent variable for
accountants. Attorneys and accountants place a
very high value on their time and later conversations with the participants suggested that
many were reluctant to spend the time taking
the survey. Participant fatigue is a challenge in
policy-capturing methodologies (Aiman-Smith,
Scullen, and Barr 2002), making it difficult to
get busy professionals to complete the instrument and limiting the number of scenarios that
can be shown to a participant. We have tried to
balance the amount of evaluations with the
amount of time it takes to complete the instrument, which is consistent with the literature
(Aiman-Smith, Scullen, and Barr 2002; Karren
and Barringer 2002).
Second, we utilized only U.S. professionals
located largely in the Midwest. As business
entities are different in other countries, we
cannot extrapolate beyond the United States in
our research. Also, although we have a balance
of larger and less populated areas, Midwest
professionals may make different evaluations
than other professionals, especially as the costs
to form and file the various entities vary from
state to state (Blair, Marcum, and Fry 2010).
Future research on advisers from other areas in
the United States may be useful as the laws
related to business formation decisions are
state statutes which vary from state to state. In

BLAIR AND MARCUM

263

addition, the international implications are hard


to measure as the legal entity formation choices
differ internationally as does the law (Klapper,
Amit, and Guilln 2010).
We based the factors we chose on prior
research and interviews with professionals. It is
possible that there are more important factors
that we missed. We also only examined two
types of advisers, although many scholars
argue that other advisers (e.g., insurance
agents, business consultants, investors) should
also be queried. Future research could examine
other factors and advisers.

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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