videojug.com - "Small Business Basics" by Chas Rampenthal

Name: Chas Rampenthal
Job: Attorney-at-Law
Summary: Chas Rampenthal is a founding partner of Endeavor Legal in Boston, MA. While practicing law in Massachusetts and California, Mr. Rampenthal can be heard on his radio show, "Legally Bound" on KTLK.


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Small Business Basics
Do I need a legally recognized form of business?

The first questions that someone should ask themselves, of course, after they come up with an idea and have some idea of what it is that they want to do for a business, is whether or not they should have a legally recognized or a legally separate business. And when individuals come to me and ask this question, I tend to look at a lot of the factors that would assist them in making that decision, for instance, whether or not they have a vision for the company that shows growth. Obviously, massive growth or the ability to attract investors or other partners or people is one thing that would come into it. What their tax concerns were would be another. The size - whether or not they were going to be hiring employees. If they were going to operate their business in more than one state or territory, and probably what their taste for liability was. If they were a little more risky or if they're a little bit more risk-averse. I think initially those are the really big factors that I like to hammer down with someone who is trying to make that decision.
What legal factors should I consider when starting a business?

Legal factors in starting a business: The number one that I always am concerned about when I'm advising individuals is liability. I take a look at what their business is. Someone who is, for instance, baking cookies out of their oven, they have a different risk than someone who is developing a chemical that's going to be spread on tomatoes or something like that. You take a look at all the risks and all the liability and what can come from it, and that's one really large factor. Additionally, whether or not they want to take in outside investment capital. If you were planning on taking in outside investment capital from a passive investor, or a venture capitalist, or what people call an angel investor, then a legally recognized business is going to definitely benefit you, and it's going to give you a little bit more legitimacy. It also allows for passive ownership, which some of the other ones don't. There is, though, the concept of having a legitimate business. When someone goes through the steps of forming a corporation or a limited liability company, other people can take a look at that and think that person might even be more serious or that might be that thing they really want to do. So those are the really main factors that I look at. Additionally, you think of taxes, like I said whether or not they would hire any employees, and the size of their business, some of the things that they're planning on doing with it, and, for instance, the biggest one to me, also, might be just what their goals are. Do they want to keep a small, little mom-and-pop shop, or do they want to grow this into a massive business that is going to be name-known everywhere?
What is a "sole proprietorship"?

A sole proprietorship is essentially me doing business as myself. If I am a sole proprietor, or one of my clients is a sole proprietor, they don't have a separately recognized legal entity that they're doing business under, like a corporation or a limited liability company. Sole proprietorship is if I were a plumber, and I wanted to go out and start up my own plumbing shop, I could say this is Chas Rampenthal Plumbing Shop; I do business under my own name; I am the business. Since there's nothing separate in a sole proprietorship, all the debts are all my own personal debts, all the income is my own personal income and all of the liability is my own personal liability.
What are the pros and cons of forming a sole proprietorship?

There's actually a few pros and cons both. The pros for forming a sole proprietorship is that you don't need to form it, it just happens. The day you start doing business it's formed. Nothing else really need to happen, additionally there's no formalities. There's not legal paperwork to file. It's very inexpensive because there are no actual formalities. The cons are a little bit tricky and would depend on what your appetite is for risk. Again all the liabilities you would incur if someone were to sue your business; they would be suing you personally. There's no business to fall back on. If you were to lose that lawsuit you stand a chance to lose anything you own. Whether it's a home or prized possessions or a car. Anything that wouldn't be excluded under bankruptcy. Again if you business goes bankrupt, you personally go bankrupt. Also there are some tax limits. Whenever you're filing you individual taxes you would file them on a schedule C- which is a separate business income instead of filing a whole separate return for the company.
What is a "general partnership"?

A partnership is very similar to a sole proprietorship, but just add more people. In other words, there's no distinct, separate, separately recognized legal entity. What a partnership is is anytime more than one person gets together and they're doing some sort of thing, whether its a business or its fixing up a car together or whatever, they are in a general partnership. A general partnership, both of the partners or any partner, if its more than two, can bind the company with a contract. For instance, if I were general partners with my best friend in an endeavor to start a new business, if my best friend went out and signed a multi-million dollar contract for telephone service, I as the other general partner and my entire partnership would be bound by that. And also, if for some reason our partnership was sued, both individuals are sued together, and if one person, lets say myself, I didn't have any money and couldn't satisfy a judgement, the entire judgement would have to be satisfied by the other partners. So what that means is all partners have unlimited liability for debts and credits, creditors of the company, and additionally, all of the partners are responsible for the income, so when income comes in, its split among the partners equally according to their proportion. Now, with the general partnership you can get a little bit more creative and help to make it a little bit more legally efficient and that is by signing a partnership agreement, something that typically a lawyer would do or you'd go to a lawyer and have them draw up, as to what everyones rights and responsibilities were in a partnership.
What are the pros and cons of forming a general partnership?

The pros and cons - I think that the pros, first off, are very similar to the pros for a sole proprietorship. As soon as you get together with a friend and say, "Let's do this," and you start doing a business, you have one. You have a general partnership; you don't need to sign an agreement, you don't need a lawyer, you don't really need anything; all you need is an idea and a little work behind it. The cons, also very similar to the cons for a sole proprietorship, are in that every single partner has unlimited liability; every single partner's responsible for debts. If someone sues that business, both or all of the partners could end up being bankrupt, and each of their houses could be seized. Any assets that they own could be seized. The one additional con that you have with a general partnership that you don't have with a sole proprietorship is the fact that any partner or any of the general partners can bind the business in a contract just by talking with a vendor. Someone could call up and say, "Hey, we'd like to sell you this new device, or this new thing", and if someone says, "Done - I want it," the entire business including the other partners who didn't even vote for it are responsible for it.
What is a "limited partnership"?

A limited partnership is different than both the sole proprietorship and a general partnership, in that it is a separate legal entity - it's filed with the state. What a limited partnership is, is one general partner. That general partner has unlimited liability for debts and assets and everything, and is responsible for running and the operation of the company, and all of the limited partners that are along with the general partner, are typically passive investors. For instance, a lot of film productions are limited partnerships, a lot of venture capitalists and people who do passive investing are limited partnerships. Real estate companies typically can be limited partnerships. The reason why this is is there's usually one person, and by the way, a general partner of a limited partnership can even be an entity, like a limited liability company or a corporation, so that way even though the general partner has unlimited liability, if it is a separate structure, a lot of times it will still enjoy, the individual owners will enjoy a certain type of limited liability.
What are the pros and cons of forming a limited partnership?

Limited partnerships offer each of the limited partners (in other words, not the general partner) limited liability, as long as that limited partner doesn't actively participate in the management of the company. This means that if a limited partner, for instance, only owned one or two percent of the company, and there was a judgement against it, they would only be liable to the actual amount that they had invested, and not for more. Additionally, it's a separate legal entity, unlike a regular general partnership, so that it can open up a bank account in its own name; it can conduct business and own property, and things like that, in its own name, and not in any one individual name. Some of the disadvantages, however, of a limited partnership are that the general partner still has unlimited liability; so unless the general partner is formed as its own separate company, that individual (if it is an individual) would be subject to all the debts and personally liable, even, for some of the debts of the company. Additionally, I think that there can be some issues surrounding how the limited partnership is run. In other words, if you want more people and some of these limited partners to actively participate in the company, a lot of times some of them would be reluctant to do so, because of the liability issues.
What is the difference between a general partnership and limited partnership?

A limited partnership is, as it says, it has limited partners. That's the big difference. Every general partnership, each one of the partners, whether there's two or two hundred, is a general partner. Each one of those general partners has unlimited liability when it comes to debts of the business or liabilities of the business. For limited partners, however, as long as they don't participate in the active management of the company, they're only liable up to the amount of their investment, or the percentage of their investment. So if a lawsuit occured for a general partnership, each one of the partners could be sued for the entire amount. Whereas in a limited partnership, which is also a separate legal entity, only the limited partners--again, as long as they don't participate in the management of the business--their liability will be limited, which is very good and it actually helps get passive investors in to a company.
What is a "corporation"?

A corporation, unlike a sole proprietorship or a partnership, is a separate legal entity. It is, in a sense, a new legal person, whereas I am a natural person. So, a corporation can own property, it can open bank accounts, it can conduct business, it can hire employees, it can do pretty much everything that a natural person like myself can do. The things that a corporation does even more though, is it allows for a lot greater flexibility when it comes to raising capital, to eliminating liability, to assisting you with taxes and tax planning. And also, growing the business, raising capital, keeping capital in the business, it just becomes way easier to do a lot of those things when you have a corporation.
What are the pros and cons of forming a "C corporation"?

A "C" corporation is the "default corporation." Whenever you file or organize a corporation in any state in the United States, it is automatically classified as a "C" corporation for IRS and tax purposes. Some of the benefits for any corporation, whether it's a "C" corporation or not stand true. The liability of a C corporation's owners is limited to the amount that they have invested. So, if you invested a certain amount in and the C corporation is sued, only the amount that's inside the C corporation could be affected or drawn upon in the proportions of the ownership. Additionally, C corporations have abilities just like another person. C corporations can hire employees, they can do almost everything another person can do, with some added benefits of allowing for better tax planning. With "C" corporations, you can even retain earnings at the corporate level to grow your business or to help entice investors or to make strategic partnerships or to purchase other companies, so you can do things with a C corporation that you can't do with other types of corporation, or even with sole proprietorships. Some of the cons of a C corporation, are that it's a little expensive. A lot of times your C Corporation could require, the help of an attorney or a legal document preparations site online, or going and researching online could be time consuming. I think the upkeep of a C corporation can be a hassle for some people. There are formalities and things that have to be taken care of by the directors and the officers of the C corporation. Additionally, you have to file a separate tax return for the C Corporation. A lot of individuals are perfectly comfortable filing their own taxes, but often filing a business tax return can be a little bit daunting for the average person. And the overall time and energy expended running a C corporation can be a little more difficult, so you should always take a look at whether the pros outweigh the cons for each individual case.
What is a "limited liability company"?

A limited liability company or what almost everyone likes to call an "LLC" is very similar to a corporation. As a matter of fact, it has all of the good parts of corporations and all of the good parts of partnerships as well. What I mean when I say it's like a corporation, is that it is a separate legal entity. There is a filing made with the state. You have to let everyone know. You have to organize it and follow certain procedures. But instead of a normal sea corporation that's formed whenever you form a corporation in the state, the profits of an "LLC" will flow straight through to the individual owners - what everyone calls members of a limited liability company. Additionally, limited liability companies have a lot more flexibility typically than corporations when it comes to how they're managed. There is an operating agreement. There is a little bit less corporate formality as well.
What is the minimum number of members required to form an LLC?

In the past few years this has actually changed; I'd say probably within the last 7 to 10 years. When limited liability companies were first coming to the forefront, which has actually only been for about the last 25 years, you had to have two or three members a lot of times, because a lot of people thought that it was kind of silly to have 1 person as its own company. However, all 50 states right now have agreed that 1 member limited liability companies are fine.
What are the pros and cons of forming a limited liability company?

A lot of the things that are good about forming a limited liability company is that in my opinion, it takes a lot of the great aspects of corporations and a lot of the great aspects of a general partnerships and combines it into one entity.For instance, like a corporation, it has limited liability for its members or owners. Additionally, like a partnership, the income that is received or the revenues that are received from a limited liability company flow directly through to each of its members. Therefore, at the end of the year, even though the limited liability company will have to file a tax return, it's a zero tax return and there's no separate tax that's imposed on a limited liability company. Now, some of the cons similar to a corporation are that it can be a little costly to form. You have to go through a process and form it at the state level. And, there are some formalities that you have to adhere to even though, in my opinion, compared to a corporation, the formalities are a lot less.
What is the difference between an LLC and a corporation?

There are a lot of differences, as a matter of fact, and I think that can be explained by looking at the advantages of each of them. In my opinion, the advantage of an LLC, and there are several of them. Number one, it's automatically treated like a pass-through entity without making an S-corp election, which is what you'd have to do for a corporation. That means that taxes and earnings, as they're earned by the company, are flowed directly through to its members or owners and that there's no separate or double taxation of profits at the corporate level. Additionally, with an LLC, there are fewer corporate formalities. The requirement of taking meeting minutes and having certain board of director meetings that you have for corporations isn't present when it comes to a limited liability company. Also, when you look at a limited liability company and an S-corp, which look a lot like the same from a tax perspective, however limited liability companies offer more flexibility in that individuals who are shareholders or not shareholders but the members of a limited liability company are not restricted in number like they are for S-corps. They can be entities or other non-natural people and they can also be non-U.S. citizens, which isn't the case for that. Now, there are some definite benefits to having a corporation. Typically, those benefits are that if you wanted to retain earnings at the corporate level, that is automatic when you have a C-corporation. Also, at times, depending on the type of corporation you have and the types of benefits and fringe benefits that you have in a corporation, you can have better tax treatment of a C-corp and also, like I said, the ability to retain earnings. And even though you might be taxed on them at the corporate level, a lot of companies require that and actually need that type of cash retention.
What is an "S corporation"?

An "S corporation" is essentially a tax status. Every corporation when it's filed is classified as a "C corporation" and in order to make your corporation an "S corporation" you have to file a form with the IRS, I believe it's Form 2553, and then your corporation is essentially taxed like a partnership. So, whereas a "C corporation" incurs tax at the corporate level on profits that it makes, and then a second tax to the individual shareholders when profits are distributed to them, an "S corporation" is taxed only once, and that's as the profits flow straight through to each individual shareholder, and they're taxed individually at their personal income tax level. Now, in order to qualify for an "S corporation", the "C corporation" that you form has to meet certain minimum requirements. Typically there's a few qualifications that you have to meet: number one, you have to have fewer than one hundred shareholders, each of the shareholders has to be a US citizen, and generally it would have to be a natural person, with some very few limited exceptions. There has to be a fiscal year end date, in other words a tax reporting date, of December 31st, and you aren't allowed to have any preferred stock. And that means that if you would like to have someone come in and make passive investments, you wouldn't be allowed to give them different rights than everyone else had, which can be very limiting when you're raising money.Last, but not least, if you want to have "S corp" status or treatment in a current fiscal year, the year that you start the corporation you typically have to file your IRS Form 2553, which is the "S corp" election, within 9 days of starting the company, or else you have to wait until the next fiscal year in order to get that treatment.
What are the pros and cons of forming an S corporation?

Some of the benefits of forming an S Corporation are that it's treated, your corporation, the C Corporation that you actually had when you first filed it is treated more like a partnership, and that is that the profits that it's receives are going to flow straight through to every one of the individual shareholders in proportion of their ownership. That allows for no what's called "double taxation" - in most C Corporations when the company makes a profit it will get a corporate tax on that profit. Then, if it wants to take those profits and distribute them to it's shareholders as a dividend, that "shared dividend" would also be taxed on the individual level, essentially, the one chunk of money that you make gets taxed twice. So that's a great thing to have whenever you're an S Corporation. Now, some of the disadvantages are, a lot of people when they have a C Corporation, they want the ability to retain earnings at the corporate level, to hold money in a sense, and not distribute it to all the shareholders. They might want to take the money and grow, they may want it to do a strategic acquisition, and they would be able to do that without asking for individual investments from each of their shareholders again.
What is the difference between an S corporation and a C corporation?

An S corporation is taxed differently to a C corporation. Essentially, they're both corporations. However, one of them receives a different tax treatment. C corporations receive what I would call a normal tax treatment. A normal corporate tax treatment in that profits that a C corporation makes are taxed at that corporate level. You have to file a corporate tax return at the end of every fiscal year, and then, if profits are distributed to shareholders, they are personally taxed on that as some sort of an income or capital gain depending on how their treatment of it is done. With respect to an S corporation, it is treated as a partnership for tax purposes. So, you're not allowed at corporate level to retain any income or any profits. They all must be passed through to the individual shareholders. Therefore, it's reflected completely on their individual tax returns.
What is a "non-profit corporation"?

A non-profit corporation is, again, another type of a corporation. In general, when you file a non-profit corporation or you file to organize a non-profit corporation there are some formalities that are different in most states when you actually form it. Most states would actually require you to state what your purpose is. In many states there has to be more than just one director. Many states require three. Some states even require that some of the directors are not actively involved in running the business, and that keeps it more on the level, in a sense. Now just because you have a non-profit corporation or file one, it doesn't always mean that you're going to have non-profit status with the IRS. That is a completely separate filing that we should talk about, called a 51 filing, and there are many different ways that you can file to get tax-exempt status. The most common one is 51C3, which is a charity that a lot of people are very familiar with. There can be just dozens of different types of non-profit corporations; they can be political, aspirational, educational, scienctific, religious, mutually beneficial etc. Obviously every state is a little bit different, but overall, the difference between a profit corporation and a non-profit corporation is that profit corporations are there for one thing: profit. Non-profit corporation is there for something different, and it's typically for improving society, making the world a better place or some other type of charitable or higher purpose rather than just putting money into people's pockets.
What are the pros and cons of forming a non-profit corporation?

The biggest pro of all is that you can receive and you can be eligible to apply for tax exempt status with the IRS. That means that everything that you do and earn doesn't actually get taxed. So that's amazing and obviously that's a huge windfall, but that's the reason why the IRS has put that out there and allowed for it is because they want to encourage charities, companies, and corporations that are for the benefit of something other than lining your pockets. Some of the draw backs is the cost. Filing and upkeeping a 501 filing or a tax free filing requires a lot more time, and a lot more disclosure. There are many legal requirements and the application is quite laborious as well. There are some people that can help you out with those small business requirements. You can always go and see an attorney, and there are some online companies that can help you as well. In general you need to know what your appetite for upkeep on a corporation is. Additionally, even if you have a non-profit and you do a really good job of starting it, you've got to maintain it, and if you don't you could actually blow your tax free status. Doing something silly like taking a certain amount of money and using it more like a profit or keeping money in there can ruin the whole thing for everyone. So it takes very tight controls and you should have someone who understands accounting and someone who really understand how to run a non-profit organisation helping you. I think additionally, one of the pros is that you can take donations from people and you can market it. They will get a tax break so if you host a charity dinner and it's $100 a plate and the dinners were only $30, someone can get a $70 tax write off. Or for instance if you accept a donation of $100 the whole entire $100 can be a write off to the individual person, and obviously that has good tax ramifications for them.
What are the major attributes that establish a corporation as non-profit?

The first one usually is the purpose of the company. Just like a general corporation where there is a C or an S corporation, where its goal is to maximize profits and make a return for its shareholders. That's kind of the complete opposite for a non-profit corporation. The goals and aspirations of a non-profit corporation are typically charitable in nature. They would be to help other people out or for the betterment of society, for education, for religion, for politics. There are a lot of reasons you can start a non-profit corporation, but the only reason you can't start one is to make money. Essentially, the only way that non-profits actually take in money, they usually do it through donations or through charitable giving. And then all of the money that they use is really earmarked to be spent out whether it's on salaries for the people who are on its staff or to do some of the good that it's doing. For instance, a medical research non-profit might take a good chunk of its money and put it towards cancer research or towards a hospital that was conducting cancer research.
What is an "Employer Identification Number"?

With small business basics, an "Employer Identification Number" is also called an EIN, Tax ID or Federal Tax ID. An EIN is essentially a Social Security Number for a business. So, if your business wants to open up a bank account, hire employees or file its taxes separately, it's going to need an Employer Identification Number or a Tax ID number. You can get that by filing out a simple form SS4 with the IRS. There just has to be an individual who is responsible for taking care of the taxes and making sure everything's done. You can usually get an EIN almost the same day if you file it.
Do I need an Employer Identification Number?

Whether or not you need an Employer Identification Number depends on a few factors. Not everyone does need an Employer Identification Number. In my opinion, I think it's always better if you are running a business to have an Employer identification number than to not have one. There's a few reasons for that, even though if I'm a sole proprietor and I'm running a small little business out of my home, I don't care if it's a doing web design or it's baking pretzels, I don't necessarily need a separate Employer Identification Number; I can do everything under my personal bank account, under my own name, and under my own Social Security number. However, if you have any aspirations of growing your business or you like to keep things separate and not commingle your funds, I think it's good to have a separate Employer Identification Number because you can open up a separate bank account for the business and it allows you to keep separate records and I think doing that legitimizes the business, and so for most people I recommend that if you're serious about your business you should probably get an Employer Identification Number.