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Choice of Entity

Every business owner should take the time to consider the right business structure for their business. Ideally, this choice should be made early on - before seeking financing or signing any contracts. But restructuring opportunities are available for those who would like to change the form of an already operating business.

Colorado business owners can select from an array of business-entity types. Informed selection among these options generally allows owners to achieve objectively better results.

Every business structure comes with its own advantages and disadvantages, in terms of tax and liability implications as well as costs and paperwork requirements. It is up to the individual owners of each business to weigh these considerations and make the tradeoffs that work best for them and their business needs.

Below is a general overview of common entity choices. For more detailed information on a particular type of entity, please click on the title of any specific section. If you would like advice or assistance, the Pote Law Firm counsels clients in entity selection and can prepare the required documents for filing.


Sole Proprietorships

A sole proprietorship is the default form for a single individual operating a business. Nothing has to be filed in order to operate a sole proprietorship, so long as the business is not operating under a tradename. The ease of formation and maintenance of a sole proprietorship is perhaps its chief advantage.

Simplicity, however, does not come without costs - the most important of which is that an owner of a sole proprietorship is personally liable for any and all business debts, obligations or acts. Furthermore, sole proprietorships do not have the tax or management flexibility that limited liability companies offer businesses with a single owner.

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A sole proprietorship operating under a tradename must register that name with the Secretary of State. A sole proprietorship operates under tradename when it uses any name other than the owner's legal name.

If you need assistance with tradename registration or obtaining permits and licenses, Pote Law Firm may be able to help. To learn more, click here.


Partnerships

Partnerships are a general category that can encompass several related kinds of entities, ranging from simple informal arrangements to complex ownership and management structures expressed through lengthy, precisely worded agreements.

On the simpler side, a general partnership is the default structure for two or more persons who are operating a business for profit, sharing in profits and losses. As a result, the creation of a general partnership has no filing requirements, and requires no written or explicit ownership agreement.

Without an explicit agreement, the business' structure and the rights and obligations of partners will be governed by statutory default rules.

These default rules may already specify terms that work best for a particular partnership. But modifications, tailored to the needs of particular businesses, are common. And regardless, prudent partners should understand these rules before letting them govern the foundational conditions of their partnership.

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Although it is possible to form any partnership without a written agreement, it is important for partners to reach an agreement upfront so that they can organize the partnership to best suit their needs and the needs of their business. Formalizing a partnership agreement upfront can also help partners plan for contingencies, even unpleasant ones, before any such situation arises.

Partners have considerable flexibility when it comes to the terms of their flex agreement. To learn more about partnership agreements, click here.

While general partnerships do not have filing requirements, any other sort of partnerships can be created only by filing the appropriate constitutional document with the Secretary of State.

The partnerships that require filings - (i) limited liability partnerships, (ii) limited partnerships, and (iii) limited liability limited partnerships - allow partners (a) to attain limited personal liability of general partners, (b) to admit limited partners (who are basically equity investors, protected from personal liability but excluded from management), or (c) both. For more information on forming a partnership, click here.

The Pote Law Firm works with small business owners to help them properly register their business and to draft partnership agreements. If you need assistance, please Reach out, Today!


Limited Liability Companies

Limited liability companies (LLCs) are relatively new but popular entities that combine aspects of partnerships and corporations. LLCs are a popular choice because of the personal liability protection afforded to its “members,” i.e. owners. Moreover, LLCs also offer considerably greater tax and organizational flexibility than a corporation or sole proprietorship would provide.

An LLC is formed when its Articles of Organization are filed with the Secretary of State. The Articles themselves are generally relatively short documents, but they carry considerable significance. The most significant question involves the LLC's management election.

LLCs may be created as either member-managed or manager-managed. In a member-managed LLC, the members participate directly in the management of the business much like general partners do. In a manager-managed LLC, ownership is separated from management in much the same way as a corporation.

However, the same person may be both a member and a manager, with the rights and responsibilities of each role.

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The seemingly simple management election in the Articles of Organization carries considerable significance...

The seemingly simple management election in the Articles of Organization carries considerable significance for the structure of the business and the rights and obligations of the members. Do you want each person with a membership interest to be able to act on its behalf and bind it to obligations? How should powers and duties be defined? Are limitations or expansions warranted?

An operating agreement allows members to work out answers to these questions in advance to help avoid costly disagreements down the road. It is also useful to draft conditions for important entity events or circumstances, such as changes in ownership or dissolution. As with partnerships and other entities, default rules establish the structure, roles and, duties where an operating agreement is silent. To learn more about operating agreements, click here.

By default, there are restrictions on the admission of new members, even the free transfer of membership interests is also allowed. However, operating agreements help here too, allowing members to draft any limitations or restrictions according to the agreements the members.

LLCs are relatively new and the state-to-state tax and liability treatment is not uniform, and may vary depending on whether the LLCs is single- or multi-member. For more on forming an LLC, click here.

The Pote Law Firm works with small business owners to help them properly register their business and to draft formal ownership agreements. If you need assistance with forming an LLC or drafting or reviewing an operating agreement, Reach out, Today!


Corporations

Corporations come in various sizes and may be either publicly or privately held. A corporation is a distinct legal entity apart from its ownership (“shareholders”) and its management is also separate from ownership. As distinct legal entities, corporations are stable and continue in existence unaffected by transfers or sales by ownership.

Shareholders acquire ownership in the corporation and are entitled to share in profits when distributed.

Because of the organizational separation between ownership and management, shareholders are entitled to protection from personal liability for the debts, obligations, and acts of the corporation.

Instead, a corporation's shareholders are potentially liable only to the extent of their financial investment in the corporation - contributing to a corporation's greater ability to raise capital than most other business entities.

Corporations may also issue a variety of types or "classes" of stock with different rights and returns, entitling the holder to different shares of profits when distributed.

Corporations must adhere to certain formalities, including:

  1. Adoption of bylaws;

  2. Establishing procedures for annual shareholder meetings;

  3. Electing a board of directors;

  4. Maintenance of corporate records;

  5. Complete separation of personal and business finances; and

  6. Proper annual filings with the appropriate Secretary of State’s office.

A corporation is formed by filing Articles of Incorporation with the Secretary of State and adopting bylaws. For more information on corporate bylaws and shareholders' agreements, click here.

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C-Corporations

All for-profit corporations are originally formed as C-Corporations. The Articles of Incorporation establish the initial board of directors, who must hold an initial meeting shortly after formation where officers are elected. These officers subsequently control the daily operations of the corporation and report back to the board of directors.

A board member and officer may be the same person, so long as the corporation is not too large. But any officers of the corporation must be paid a "reasonable salary."

After formation, even the organizing shareholders generally retain little decision-making power for the corporation. However, shareholders usually have the power to ratify certain major business decisions (e.g. dissolution, merger, liquidation of substantially all assets, etc.).

S-Corporations

Smaller, eligible corporations may elect S-corporation status in order to be taxed as a pass-through entity by filing Form 2553, "Election by a Small Business Corporation," with the IRS. By electing S-corp status, a corporation thereby avoids "double taxation" as the entity itself will no longer be taxed, only the income of individual shareholders.

Only domestic corporations with a single class of stock and fewer than seventy five (75) shareholders may elect to be taxed as an S-corporation. But there are additional requirements on eligibility, including limitations on the persons who may own shares.

S-corps generally have all of the same benefits as C-corps, in addition to not being taxed at the corporate level. However, S-corps may have important differences in allowable deductions and the carrying of losses. It is important to carefully consider the decision to be taxed as an S-corp and to talk to your tax advisor or attorney about the needs and circumstances of your particular business.

Non-corporate business entities may also be eligible to be taxed as S-corps. Such entities are normally untaxed at the entity level, but electing S-corp status allows business income to be divided between salaries and dividends, thereby potentially achieving tax savings. However, as noted above, it is important to be sure that any salaries paid are in fact "reasonable salaries."

The Pote Law Firm works with small business owners to help them properly register their business. If you need assistance with forming a corporation, electing S-corporation taxation, or drafting or reviewing bylaws or shareholders' agreements, Reach out, Today!




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