Question: One of the most important decisions that an entrepreneur makes is the selection of the form in which to do business. To make the best decision, a businessperson should understand all aspects of the various forms, including legal, tax, licensing, and business considerations. It is also important that all of the participants in the business understand their actual relationship, regardless of the organizational structure. Number of Participants During the last decade or so, new forms of business organizations, including limited liability partnerships (LLPs) and limited liability companies (LLCs), have been added to the options for business entities. An initial consideration in choosing between these forms is the number of participants. An LLP must have two or more partners, but in many states, an LLC can have a single member (owner). Liability Considerations The members of an LLC are not liable for the obligations of the organization. Members' liability is limited to the amount of their property (investment) interest. The liability of the partners in an LLP varies from state to state. About half of the states exempt the partners from liability for any obligation of the firm.
In some states, the partners are individually liable for the contractual obligations of the firm but are not liable for obligations arising from the torts of others. In either situation, each partner may be on his or her own with respect to liability unless the other partners agree to help. Distributions from the Firm Members and partners are generally paid by allowing them to withdraw funds from the firm against their share of the profits. In many states, a member of an LLC must repay so-called wrongful distributions even if she or he did not know that the distributions were wrongful. Under most LLP statutes, by contrast, the partners must repay only distributions that were fraudulent. Management Structure Both LLPs and LLCs can set up whatever management structure the participants desire. Also, all unincorporated business organizations, including LLPs and LLCs with two or more members, are treated as partnerships for federal income tax purposes (unless an LLC elects to be treated as a corporationa). This means that the firms are not taxed at the entity level. Their income is passed through to the partners or members who must report it on their individual income tax returns. Some states impose additional taxes on LLCs.
The Nature of the Business The business in which a firm engages is another factor to consider in choosing a business form. For example, with a few exceptions, professionals, such as accountants, attorneys, and physicians, may organize as either an LLP or an LLC in any state. In many states, however, the organizational form of an entity that engages in a certain profession and the liability of the owners are prescribed by state law. Financial and Personal Relationships Although the legal consequences of choosing a business form are certainly important, they are often secondary to the financial and personal relationships among the participants. Work effort, motivation, ability, and other personal attributes can be significant factors, as may fundamental business concerns such as the expenses and debts of the firm-and the extent of personal liability for these obligations. Another practical factor to consider is the willingness of others to do business with an LLP or an LLC. A supplier, for example, may not be willing to extend credit to a firm whose partners or members will not accept personal liability for the debt.
CHECKLIST FOR CHOOSING A LIMITED LIABILITY BUSINESS FORM
1 Determine the number of participants, the forms a state allows, and the limits on liability the state provides for the participants.
2 Evaluate the tax considerations.
3 Consider the business in which the firm engages, or will engage, and any restrictions imposed on that type of business.
4 Weigh such practical concerns as the financial and personal relationships among the participants and the willingness of others to do business with a particular organizational form.