Question

identify the appropriate business formation for the following: Denies, a lawyer, decided to start her own law practice. She will have a paralegal, a secretary and a filing assistant. She is considering having other lawyers as associates or partners. She will borrow $100,000 for start-up costs. Ideally, she does not want to have any liability if she is sued for legal malpractice. Explain whether she should form the business as a sole proprietorship, a personal corporation, or partnership. The answer should explain the advantages and disadvantages of Denise forming each of the formats suggested

Answer 1

ANSWER. Sole proprietorship

A sole proprietorship is a business owned and managed by a single individual. It is the most common and simplest type of business entity. A sole proprietorship can have multiple people operating the business, but it must have one sole owner. Sole proprietorships have several advantages over other business entities. They are easy to form, and the owners enjoy sole control of the business profits. However, they also have disadvantages, the biggest of which being that the owner is personally liable for all business losses and liabilities.

If she starts her business as a sole proprietor, she will have the following advantages and disadvantages:

Advantages

• you’re the boss
• you keep all the profits
• start-up costs are low
• you have maximum privacy
• establishing and operating your business is simple
• it’s easy to change your legal structure later if circumstances change
• you can easily wind up your business.

Disadvantages

• you have unlimited liability for debts as there’s no legal distinction between private and business assets
• your capacity to raise capital is limited
• all the responsibility for making day-to-day business decisions is yours
• retaining high-calibre employees can be difficult
• it can be hard to take holidays
• you’re taxed as a single person
• the life of the business is limited.

Personal corporation

A corporation is a legal entity, organized under state laws, whose investors purchase shares of stock as evidence of ownership in it. The advantages of the corporation structure are as follows:

• Limited liability: The shareholders of a corporation are only liable up to the amount of their investments. The corporate entity shields them from any further liability, so their personal assets are protected.

• Source of capital: A publicly-held corporation in particular can raise substantial amounts by selling shares or issuing bonds.

• Ownership transfers: It is not especially difficult for a shareholder to sell shares in a corporation, though this is more difficult when the entity is privately-held.

• Perpetual life: There is no limit to the life of a corporation, since ownership of it can pass through many generations of investors.

• Pass through: If the corporation is structured as an S corporation, profits and losses are passed through to the shareholders, so that the corporation does not pay income taxes.

The disadvantages of a corporation are as follows:

• Double taxation: Depending on the type of corporation, it may pay taxes on its income, after which shareholders pay taxes on any dividends received, so income can be taxed twice.

• Excessive tax filings: Depending on the kind of corporation, the various types of income and other taxes that must be paid can require a substantial amount of paperwork. The exception to this scenario is the S corporation, as noted earlier.

• Independent management: If there are many investors having no clear majority interest, the management team of a corporation can operate the business without any real oversight from the owners.

Partnership

Advantages of a partnership include that:

• two heads (or more) are better than one
• your business is easy to establish and start-up costs are low
• more capital is available for the business
• you’ll have greater borrowing capacity
• high-calibre employees can be made partners
• there is opportunity for income splitting, an advantage of particular importance due to resultant tax savings
• partners’ business affairs are private
• there is limited external regulation
• it’s easy to change your legal structure later if circumstances change.

Disadvantages of a partnership include that:

• the liability of the partners for the debts of the business is unlimited
• each partner is ‘jointly and severally’ liable for the partnership’s debts; that is, each partner is liable for their share of the partnership debts as well as being liable for all the debts
• there is a risk of disagreements and friction among partners and management
• each partner is an agent of the partnership and is liable for actions by other partners
• if partners join or leave, you will probably have to value all the partnership assets and this can be costly.

So, therefore, according to me, Denies should go for personal corporation as she does not want to have any liability if she is sued for legal malpractice. In this form of business, there is limited liability. The shareholders of a corporation are only liable up to the amount of their investments. The corporate entity shields them from any further liability, so their personal assets are protected. The capital can also be raised easily by the sale of shares.