Imagine that you have just invented a product with a good amount of market potential. Whether you intend to manufacture your product yourself or sell it to another person or entity to manufacture, you will want to create a formal legal entity.
One of the most important decisions you will make is how to legally organize. There are several alternative structures to choose from; your choice could have a significant impact on your finances, taxation, and degree of legal liability.
There are four possible forms in which to organize your inventing business:
Some decisions are easy. If you are pursuing your inventing alone, then naturally you would not for a partnership; this business form requires two or more owners. Indeed, most inventors work alone. As a result the most common choices are among being a sole proprietor, forming a corporation, or forming a limited liability company.
A sole proprietorship is a one-owner business. Unlike a corporation or limited liability company, it is not a separate legal entity. The business owner (proprietor) personally owns all the assets of the business and is in sole charge of its operation. Most sole proprietors run small operations, but a sole proprietor can hire employees and contract with nonemployees, too.
The vast majority of all self-employed people, including inventors, are sole proprietors. Many have attained this legal status without even realizing it. Quite simply, if you start running a business by yourself (or are already engaged in the business of inventing) and do not incorporate or form an LLC, you are automatically a sole proprietor.
A corporation, like a partnership, has a legal existence distinct from its owners. It can hold title to property, sue and be sued, have bank accounts, borrow money, hire employees, and perform other business functions. In theory, every corporation consists of three groups:
However, in the case of a small business corporation, these three groups can be and often are the same person--that is, a single person can direct and run the corporation and own all the corporate stock. So, if you incorporate your one-person inventing business, you don’t have to go out and recruit and pay a board of directors or officers.
The limited liability company, or LLC, is a popular type of business form in the United States. An LLC is, in some ways, a hybrid of other business forms. Like a sole proprietorship or partnership, its owners (called members) jointly own and manage the business. Like a partnership, an LLC is a separate legal entity. An LLC is taxed like a sole proprietorship or partnership, but provides its owners with the same limited liability as a corporation. LLCs have become popular with self-employed people because they are simpler and easier to run than corporations.
A partnership is a form of shared ownership and management of a business. The partners contribute money, property or services to the partnership and in return receive a share of the profits it earns, if any. They jointly manage the partnership business. This form is extremely flexible because the partners may agree to split the profits and manage the business any way they want.
A partnership automatically comes into existence whenever two or more people enter into business together to earn a profit and don’t choose to incorporate or form a limited liability company. Unlike a sole proprietorship, a partnership has a legal existence distinct from its owners--the partners. It can hold title to property, sue and be sued, have bank accounts, borrow money, hire employees and do anything else in the business world that an individual can do.
Because a partnership is a separate legal entity, property acquired by a partnership is property of the partnership and not of the partners individually. This differs from a sole proprietorship where the proprietor-owner individually owns all the sole proprietorship property.
The decision of which entity to choose for your inventing business is important enough that you should consider consulting a lawyer or tax professional. An experienced business lawyer or accountant can help you understand the pros and cons of each legal form, with your specific needs in mind.
While the decision is important, remember that your initial choice about how to organize your business is not engraved in stone. Businesses can change their corporate formations over time as their needs grow and change. What starts as a sole proprietorship could one day grow into a large corporation with multiple classes of shareholders.