What’s Involved in Organizing an Entrepreneurial Venture?
7-3 Describe the six legal forms of organization and the choice of appropriate organizational structure.
Roy Ng, chief operating officer of Twilio in San Francisco, redesigned his organization’s structure by transforming it into an employee-empowered company. He wanted to drive authority down through the organization so employees were responsible for their own efforts. One way he did this was by creating employee teams to handle specific projects. These small teams can work rapidly and independently, and provide a means for employees to have the same level of passion, resourcefulness, and productivity that characterized the startup in its earliest days.26
Once the startup and planning issues for the entrepreneurial venture have been addressed, the entrepreneur is ready to begin organizing the entrepreneurial venture. The main organizing issues an entrepreneur must address include the legal forms of organization, organizational design and structure, and human resource management.
What Are the Legal Forms of Organization for Entrepreneurial Ventures?
The first organizing decision that an entrepreneur must make is a critical one. It’s the form of legal ownership for the venture. The two primary factors affecting this decision are taxes and legal liability. An entrepreneur wants to minimize the impact of both of these factors. The right choice can protect the entrepreneur from legal liability as well as save tax dollars, in both the short run and the long run.
The three basic ways to organize an entrepreneurial venture are sole proprietorship, partnership, and corporation. However, when you include the variations of these basic organizational alternatives, you end up with six possible choices, each with its own tax consequences, liability issues, and pros and cons. These six choices are sole proprietorship, general partnership, limited liability partnership (LLP), C corporation, S corporation, and limited liability company (LLC). Exhibit 7–5 summarizes the basic information about each organizational alternative.
Exhibit 7–5
Legal Forms of Business Organization
| Structure | Ownership Requirements | Tax Treatment | Liability | Advantages | Drawbacks |
|---|---|---|---|---|---|
| Sole proprietorship | One owner | Income and lossess “pass through” to owner and are taxed at personal rate | Unlimited personal liability | Low start-up costs Freedom from most regulations Owner has direct control All profits go to owner Easy to exit business | Unlimited personal liability Personal finances at risk Miss out on many business tax deductions Total responsibility May be more difficult to raise financing |
| General partnership | Two or more owners | Income and lossess “pass through“ to partners and are taxed at personal rate; flexibility in profit-loss allocations to partners | Unlimited personal liability | Ease of formation Pooled talent Pooled resources Somewhat easier access to financing Some tax benefits | Unlimited personal liability Divided authority and decisions Potential for conflict Continuity of transfer of ownership |
| Limited liability partnership (LLP) | Two or more owners | Income and lossess “pass through“ to partners and are taxed at personal rate; flexibility in profit-loss allocations to partners | Limited although one partner must retain unlimited liability | Good way to acquire capital from limited partners | Cost and complexity of forming can be high Limited partners cannot participate in management of business without losing liability protection |
| C corporation | Unlimited number of shareholders; no limits on types of stocks or voting arrangements | Dividend income is taxed at corporate and personal shareholder levels; losses and deductions are corporate | Limited | Limited liability Transferable ownership Continuous existence Easier access to resources | Expensive to set up Closely regulated Double taxation Extensive record keeping Charter restrictions |
| S corporation | Up to 75 shareholders; no limits on types of stock or voting arrangements | Income and lossess “pass through“ to partners and are taxed at personal rate; flexibility in profit-loss allocations to partners | Limited | Easy to set up Enjoy limited liability protection and tax benefits of partnership Can have a tax-exempt entity as a shareholder | Must meet certain requirements May limit future financing options |
| limited liability company (LLC) | Unlimited number of “members“; flexible membership arrangements for voting rights and income | Income and lossess “pass through“ to partners and are taxed at personal rate; flexibility in profit-loss allocations to partners | Limited | Greater flexibility Not constrained by regulations on C and S corporations Taxed as partnership, not as corporation | Cost of switching from one form to this can be high Need legal and financial advice in foming operating agreement |
Source: Robbins, Stephen P., Coulter, Mary, Management (Subscription), 14th Ed., © 2018. Reprinted and electronically reproduced by permission of Pearson Education, Inc., New York, NY.
The decision regarding the legal form of organization is important because it has significant tax and liability consequences. Although the legal form of organization can be changed, it’s not easy to do. An entrepreneur needs to think carefully about what’s important—especially in the areas of flexibility, taxes, and amount of personal liability—in choosing the best form of organization.