The first lesson any business person should adhere to is protect yourself and your family. Unfortunately, most businesses start off haphazardly and either by design, or default, operate as sole proprietorships. By definition, a sole proprietor is someone who is in business as the sole owner himself or herself. While proprietorships are the simplest form of business, easiest to start, do not require any particular formality, and allow the owner to be king or queen of their business, the down-side risk is unlimited personal liability. The only thing worse than a sole proprietorship is a general partnership. A partnership is created when two or more people come together in the common pursuit of a business.
Like proprietorships, they do not have any formal requirements, however, any time there are multiple owners a business should have a written agreement to delineate their respective ownership interests, responsibilities, compensation, authority, voting rights and contingencies for death, disability, termination, etc… Otherwise, the owners are deemed to be equal in all respects. In a general partnership, not only is each partner subject to unlimited personal liability for anything and everything they do or fail to do, they likewise have unlimited personal liability for anything and everything each and every one of their partners does or fails to do. Both proprietorships and general partnerships are completely unacceptable entity choices in today’s business and legal environment.
Thankfully, there are alternatives which can protect business owners. Corporations have been around long before the founding of our country and provide excellent protection from virtually all business risks. Corporations enjoy what is known as limited liability protection for its owners (shareholders). A trade-off is adhering to certain formalities, including the requirement of filing articles of incorporation with the State, obtaining a corporate seal, issuing stock certificates to each of the shareholders evidencing their ownership interests, advertising in both the general circulation newspaper and applicable county bar journal, holding annual meetings of the shareholders and directors, etc… Additional formalities include the use of a corporate designator in the formal name (corporation, incorporated, company, limited or the applicable abbreviation) and segregation of corporate funds from personal monies.
Limited liability companies are the newest alternative. Though they have only been recognized in Pennsylvania since 1994, they have become the entity of choice for businesses seeking to protect their owners from personal liability. While they too require filing formal articles of formation with the State, they are not technically subject to the seal, stock certificate, advertising, or annual meeting requirements. They do share the fundamental requirement of using the proper designator, such as LLC, and are likewise subject to the prohibition on co‑mingling monies.
Adhering to the appropriate formalities and maintaining a reasonable business ethical standard, corporations and limited liability companies will generally protect their owners from personal liability exposure. Selecting between the two is best left to accountants and tax advisors, however, without a doubt, each is a better alternative than sole proprietorships and general partnerships.