Starting a business can be a fun, exciting, and terrifying ordeal. It takes a vision, a plan, and the execution of the plan while also adjusting for events as they affect the plan.
During a lecture I was attending once, the speaker said, “Anyone can start a business, but not everyone can run a business.” That, combined with a recent conversation I had got me thinking that I should write about this topic, and all of the questions that come with starting a business. While this is a general discussion of legal principles, it will provide a good foundation of information to think about and discuss with your attorney.
The first topic that should be discussed is different business entities, some basic Business 101 type of information. Some states recognize different entities, and not every entity is recognized in every state. There are four basic types of business entities, and each offers benefits and drawbacks.
- Sole Proprietorship
- Limited Liability Company
A Sole Proprietorship, defined in Black’s Law Dictionary 9th Edition, is (1) A business in which one person owns all the assets, owes all the liabilities, and operates in his or her personal capacity; (2) Ownership of such a business.
A Sole Proprietorship is the most basic business entity, and it is essentially just a person that is doing business on their own. The benefit is that there are minimal (if any) government requirements and it is fairly easy to maintain the business. The drawback is that essentially personal and business assets are the same and if the business is sued, and the business loses, all of the business assets and all of the personal assets may be lost because there are no limits to liability with a sole proprietorship.
The easy part: A Partnership, defined in Black’s Law Dictionary 9th Edition, is a voluntary association of two or more persons who jointly own and carry on a business for a profit. Under the Uniform Partnership Act, a partnership is presumed to exist if the persons agree to share proportionally the business profits or losses.
The more confusing part: There are different types of partnerships (over 20 listed in Black’s Law Dictionary) including a general partnership, limited-liability partnership, and a limited partnership. In general terms, without a government filing that meets the government requirements, you will form a general partnership.
A General Partnership is easy to form, with or without anything in writing. In the conversation that I referred to above, there were a group of four people that decided to start a business together, and then decided to add a fifth partner and said they would decide the ownership interests later. They decided what the business would be, and who owns what percent of the partnership and they started the business, which for simplicity I will refer to as “Acme Plumbing” (of course not the real business name). They proceeded to start the business, and the business funds were deposited into one partners bank accounts to be distributed to other partners. Another partner handled the ‘petty cash’ funds through their personal bank account.
Everything was going great, but they lost a $20,000 client, according to them, because they did not have a Limited Liability Company. I believe there were more issues that they do not realize, but that is the reason they provided. One of the issues that I noted was that they were conducting business in a fictitious (made up) name of “Acme Plumbing” (once again, not the real name). Now if the owner was named Acme, Acme Plumbing would have been fine. However, since the business owner was not named Acme, the Partnership had failed to file a fictitious name statement with their county and is prohibited from conducting business under the name “Acme Plumbing”. These people properly formed a general partnership (easy to start a business) but failed to understand the legal requirements for doing business with a fictitious (made up) name.
Another issue that these people did not realize was that in a general partnership, like theirs, each and every partner is liable for the other partners. If one partner commits the partnership to do something (enters an oral or written contract), then the entire partnership is liable. This is true, even if the partnership does not permit that partner to enter into the agreements, as long as the third party reasonably believed that the partner was permitted to enter into the agreement.
To ensure clarity on this issue, we will explore the following hypothetical:
A Partnership is formed between Bert and Ernie to sell cookies. Bert and Ernie agree that only Bert has the authority to enter into any agreements for the Partnership and that each cookie would be sold for $1 each. Ernie then proceeds to go to Disney and enters into an agreement to sell cookies for $0.10 each, and Disney reasonably believes that Ernie has the authority to enter into the agreement, and Disney reasonably believes the price is a fair price. The partnership, and both partners would be obligated to fulfill the agreement and would be liable if they breached the contract.
Now if Ernie had spilled butter all over the floor and failed to clean up the mess, there could be liability for any injuries caused. Using the Disney hypothetical again, Disney came to the store to pick up the $0.10 cookies, and slipped on the spilled butter. Disney sues the partnership for injuries and both Bert and Ernie are jointly liable for the injuries caused by Ernie’s negligence, and both Bert and Ernie’s business and personal assets may be lost because there is no limits to liability with a general partnership.
In part 2, we will explore a couple of limited partnership options and limited liability companies.