Business Organizations

Group of Business People Discussing at Sunset Reflected Onto Tab

There are many kinds of business organizations.  Partnerships, corporations and limited liability companies are the most common.

  • A general partnership is created when two or more people agree to be partners. To form it, they do not need to file anything with the state or even a written agreement (although most lawyers would recommend one!). It is taxed as a “pass-through entity,” meaning that each item of net income and net loss are passed through the partnership to the individual partners, who are then taxed on those amounts rather than on the amount of cash that may be distributed to them. Each general partner is jointly and severally liable for all the obligations of the partnership.
  • A limited partnership has one or more general partners that are jointly and severally liable for all the obligations of the partnership, and one or more limited partners whose liability is limited to their investment and who generally cannot be sued individually for partnership obligations. Limited partners are generally passive investors who have little or no say in the operation of the business. It is created by filing organizational documents with the state and preparing a limited partnership agreement that describes the rights and responsibilities of the partners. Like a general partnership, it is a pass-through entity for US federal income tax purposes, although limited partners should be aware of how passive income and loss rules affect them.
  • A corporation is created by filing a Certificate of Incorporation or Articles of Organization with the state (the name of the incorporation document depends on the state). The organizers and shareholders then create a number of other documents including bylaws, various board of directors and shareholder resolutions and share certificates (whether there are “shares” or “stock” also depends the state). Most lawyers also recommend a shareholders agreement that describes certain rights and responsibilities of shareholders, including restrictions on transfer and, if appropriate, buy-sell agreements. It is managed using the familiar structure of a board of directors that supervises officers who, if appropriate, supervise employees. For US federal income tax purposes, a corporation pays tax on its own income, and shareholders only pay tax on the dividends and distributions they receive. However, under certain circumstances a corporation may elect to be treated as an “S corporation,” which is taxed as a partnership.
  • A limited liability company is a hybrid of a corporation and a partnership. It is formed by filing with the state and preparing a limited liability company operating agreement that looks very similar to a partnership agreement. It may be managed directly by the members or by appointed “managers,” who are like officers of a corporation. Most limited liability companies are pass-through entities for US federal income tax purposes, although they can elect to be taxed like corporations.

Most lawyers recommend that the owners sign a shareholders agreement, partnership agreement or limited liability company operating agreement that addresses many important issues including potential points of conflict. However, conflicts do arise. The precise way to address disagreements depends on the state and type of entity, but the court system typically limits suits in ways that many find surprising. The courts can sometimes order money damages, but if the owners are deadlocked over major decisions the best the courts can do is often to order that the entity be put into receivership and dissolved. We are big fans of alternative dispute resolution mechanisms to resolve partner disputes or shareholder disputes. Most are negotiated. Some require more formal mechanisms like mediation or Collaborative Law.

Consult with a business organizations lawyer about how to create the best organization for your business venture or what to do if partner problems arise.