One of the most important decisions you make when you’re first starting out is how to legally organize your inventing business. There are several alternatives and the one you choose will have a big impact on your finances, how you’re taxed and how much time you have to spend on record keeping and accounting. Keep in mind that your initial choice about how to organize your business is not engraved in stone. You can always switch later.
There are four forms in which to organize your inventing business:
- sole proprietorship
- corporation, or
- limited liability company.
If you’re inventing alone, you need not be concerned with partnerships; this business form requires two or more owners. If, like most independent inventors, you’re working by yourself, your choice is among being a sole proprietor, forming a corporation or forming a limited liability company.
On the other hand, if you’re working with one or more co-inventors who will jointly own the invention, you cannot be a sole proprietor. Your choices are limited to a partnership, corporation or 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. Indeed, some one-owner businesses are large operations with many employees.
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:
- those who direct the overall business, called directors
- those who run the business day to day, called officers, and
- those who just invest in the business, called shareholders.
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.
Limited Liability Company
The limited liability company, or LLC, is the newest type of business form in the United States. An LLC is like a sole proprietorship or partnership in that 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.
If you are working with one or more coinventors who will work together to create an invention and share in its ownership and any profits it earns, you can’t be a sole proprietor. Sole proprietorships are one-owner businesses. Instead, you must choose among three forms of business that allow for joint ownership by two or more people: a partnership, corporation or limited liability company.
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.
Read more about Inventors as a Partnership.
When to Talk to a Lawyer
If you need more help on how to choose the form of legal entity for your inventing business, contact a qualified attorney. An experienced business lawyer can help you understand the pros and cons of each legal form and help you form a corporation, llc, or partnership.