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Business Planning
Partnership
A partnership forms when two or more entities join together for a common business
purpose. Two or more people, a person and a corporation, two corporations, or even
two partnerships may form a partnership. A partnership can be general or limited.
Although no written document is required to form a partnership, for all partners sakes a
partnership agreement should be written. This document should spell out matters such
as division of profits or dissolution of the partnership.
The partners control a partnership according to their agreement. They have a great
deal of flexibility. If they have no other agreement, the law assumes that partners share
control equally. In a limited partnership, the general partner controls the operations and
the limited partner is simply an investor.
Some experts recommend avoiding a partnership, corporation, or LLC that splits
ownership 50/50. What happens if the owners do not agree? Nothing. A majority
cannot be achieved. Instead of a 50/50 ownership, a third party in whom the partners
have complete trust, could have a very small percentage of ownership or a written
agreement to resolve tie votes. If the partners agree, that person never hears from them.
If the partners cannot agree, this third party votes so the business can act.
Partnerships have a fairly simple tax structure. Income and loss earned by the
partnership passes through to the partners, and they report it on their respective tax
returns. The partners then pay the tax on their share of the profits. The partnership itself
does not pay any tax on profits.
Some authorities strongly advise against using the general partnership form of
organization for most types of businesses because liabilities are personal and unlimited.
Moreover, each partner is fully personally liable for the actions of any other partner. In
a limited partnership, only the general partner is personally liable. The limited partners
liability is limited to the amount of investment.
Since a partnership is a voluntary association, you or any partner can end it at any time.
Partners can simply say they no longer wish to be a partner. The death of a partner also
automatically ends a partnership. Therefore, a partnership agreement should include
provisions for dissolution. The agreement also covers the payment or performance of
partnership obligations, division of assets, continued use of the name and ownership of
intellectual property.
Think through all the aspects of your business before deciding on a partnership. One
land development partnership in Virginia was initially funded by three equal partners to
develop land near a new center for horse breeding, training, and racing. The partnership
contracted to develop the land with the only modern hotel and restaurant near the
new horse facility. The partners planned to sell the properties to a hotel management
company. Their investment was primed to reap huge profits for the partners.
When land development costs exceeded the initial estimates and the partners needed
to make additional contributions, only one of them had the funds to do so. Since the
partnership was contractually bound to complete the buildings, everything would
be lost if they did not perform. The partner with the funds purchased the interests of
the other two partners for far less than their initial investment and made all the profit
himself when the land was eventually sold. The partnership structure wasnt right for
the two partners who had to sell at a loss. Under a different structure they might have
been able to maintain their share in the company and then had the entity raise the
needed funds.
Business Planning
Business Planning
expecting dividends, stockholders generally have no other function. The directors make
primary decisions for the corporation, and the officers direct day-to-day operations.
Some states permit one person to fill the roles of stockholder, director, and officer.
Others permit only one owner but require two officers minimum. All states
requirements are based on the concept that the corporation is a separate legal entity
from those individuals who own and operate it.
All corporations start the same. They obtain a charter from the state, generally the
one in which they intend to do the most business. Unless the corporation elects to be
treated as a partnership for tax purposes (the subchapter S election), it files a corporate
tax return. After paying taxes, most corporations distribute money to their stockholders
in the form of dividends. The stockholders must pay taxes on the income received. This
practice results in double taxation.
To avoid double taxation, assuming certain requirements are met (no more than
seventy-five stockholders, all stockholders are U.S. citizens, and all stockholders agree),
your corporation may elect to be treated as if it were a partnership at tax time. In that
case, the corporation pays no tax and the profits pass through to the stockholders who
pay income tax on what they receive. If you make such an election, your corporation is
an S corporation or a Subchapter S corporation. The S comes from the subsection of the
Internal Revenue Code, which permits this election. A corporation that has not made
the election or is ineligible to make it is known as a C corporation.
Shares of a corporation represent ownership of the corporation. While you may restrict
shares through the by-laws of the corporation, you may transfer ownership of all or
part of the corporation relatively easily. A corporation can exist forever apart from its
founders. When you want to sell your business, the corporation provides a much more
salable package than a sole proprietorship or partnership.
The corporation is the only entity that can deduct as business expenses many benefits
such as health care and retirement plans. These expenses reduce the taxable profits of
the corporation and give employees valuable benefits which are not taxed as income.
Incorporating a business carries many advantages. One of the most significant
advantages is tremendous financial flexibility in raising capital. A corporation has the
ability to provide you the capital structure you need to accomplish your goals.
Once investors, lenders, or stockholders get involved, you need to protect your own
interests from those who might seek to take control, ownership, or profits. Even though
you start a corporation, nothing guarantees you can continue as a director, officer,
employee, stockholder, or even recipient of dividends. Nothing guarantees you will
continue to be included in the inner workings of the business. You can be squeezed out
in many ways, some direct and others very subtle. To recognize the various squeezeout methods and protect against them, rely on an experienced business attorney. These
professionals make sure your interests are protected before you commit to take on other
owners or investors. Continue to consult an attorney as time passes and the venture
changes; especially if it becomes more valuable.
Business Planning
Business Planning
Nonprofit
Some of the most profitable corporations in this country are nonprofits. The
classification as a nonprofit does not mean that the business does not make a profit
nor does it mean that it tried but failed to make a profit. It simply means that the
Internal Revenue Service has determined that it has filed for and meets the requirements
as an organization that provides a service to the community for certain purposes.
These purposes may be religious, charitable, scientific, testing for public safety, literacy,
educational, fostering a national or international amateur sports competition, or the
prevention of cruelty to children or animals.
Nonprofits are prohibited from distributing Net Income to owners, members, directors,
or officers but they may pay fair compensation to their employees. Contributions to
nonprofits are tax deductible by the donor, which is a great advantage in raising funds.
Form a nonprofit in compliance with appropriate state laws and then seek IRS
classification.
Nonprofits are controlled just as other corporations by a board of directors, but
they have no stockholders. A nonprofit does not pay income tax, but it does file
informational returns. Just as with profit corporations, the nonprofit offers insulation
from liability to its board, officers, and employees.
Since it is not always easy to determine whether a business concept will be eligible
under state and federal regulations for nonprofit status, you should contact a lawyer to
learn more about nonprofit organizations.
The Reality Checks Legal Structures and Costs of Selecting and Forming a Business
Structure should give you a good starting point so you can engage your attorney and
accountant in a thoughtful discussion. You and they will certainly want to consider
other aspects of your business structure than those suggested here, but these will give
you some idea of whats most important. Dont delay making that critical decision.