When you decide to start your own business, whether it’s a home-based sales business, or a new defense contracting business, the first thing you need to do is write a simple, one page business plan. This doesn’t need to be formal. You want to clearly define for yourself what you are hoping to accomplish. Who are your clients? How will you market? Are there additional people who need to be involved? How much time are you willing to devote to the business?
Next you need to decide on a budget. You need to have a budget for your initial expenses, like equipment and legal fees; and a budget for monthly costs, like utilities, rent, and salaries.
Once you’ve organized your thoughts by writing them down, you need to quickly decide whether you need protection in the form of a legal entity, like a corporation or limited liability company, hopefully in consultation with your attorney.
Below is a diagram of the major options you have for business entities:
|Entity?||Liability protection?||Multiple owners possible?|
|Limited Liability Partnership||Yes||Yes|
|Limited Liability Company||Yes||Yes|
- *A Sole Proprietorship is not a legal entity. It is the default when a person starts doing business on their own without making any filings with the state. There is no liability protection, which means you are personally liable for any debts or other liabilities
- In a Partnership, there can be a General Partner who has unlimited liability and one or more limited partners who have limited liability. There are also limited partnerships in which there is no general partner.
- In a Limited Liability Partnership, the partners have limited liability, unless a partner agrees to become a general partner, or liability protection is lost.
- In a Limited Liability Company, there is liability protection of the owners. A limited liability company is a hybrid entity, between a Corporation and a Partnership.
- In a Corporation, stockholders enjoy liability protection.
When deciding whether you need liability protection, you need to think of the absolute worst-case scenario you can imagine. Imagine, for example, that someone walks into your business. Imagine they trip and fall. Imagine they have an underlying medical condition that causes them to sustain multiple broken bones and endure months of painful rehabilitation, losing their income. Now what is the maximum amount that you could imagine a jury awarding someone for that worst-case scenario? Do you have that much in your checking account? If not, your savings, car, and home could all be in jeopardy.
If you (and your attorney) decide that you need liability protection, the next decision to make is what legal entity to choose and how to form it. There are many factors to consider, including tax implications, so that’s the subject of my next article.