What to do if I’m starting a business with 2 other people and we are confused as to which type of business would be best for us?

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What to do if I’m starting a business with 2 other people and we are confused as to which type of business would be best for us?

We want to be protected as individuals in case the business fails. Should we be Incorporated, Partnership or S Corporation? Our business consists of inventions that will be licensed out to investors. So, it should be more income than expense.

Asked on July 9, 2013 under Business Law, California

Answers:

SJZ, Member, New York Bar / FreeAdvice Contributing Attorney

Answered 8 years ago | Contributor

An S-corporation is a type of corporation; it is one that allows "pass through" taxation--that is, profits or losses of the corporation "pass throug" the corporation directly to the owners. As a result, there is no double taxation--i.e. the corporation does not pay a separate corporate tax. For a small corporation, a subchapter S is usually the best choice, because this sort of pass through taxation is generally advantageous.

A general partnership does not protect from liability, so it is generally not a good choice; the partners can be sued if the business owes money. To protect against liability--that is, to protect the owners' personal assets from busienss debts or liability--the best choice is either a corporation or a limited liability company  (LLC).

Between a subchapter S corporation and an LLC, there is relatively little to choice from--they are very similar in terms of liability protection and taxation. An LLC is more flexible, in that you can give the partners different ownership interests based on, among other things, how much work they will do, the intellectual property they will contribute, or the number of customers and contacts they have, whereas with a corporation, ownership interest is based purely on how much money each person invests. An LLC also involves slightly less paperwork and reporting. A sub-S corporation makes it easier to sell interests in (i.e. to sell some of the stock of), if  you think you will  bring in other investors later. If you're not contemplating adding owners/investors, an LLC is probably the better choice.


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