10/ 01/ 2002
Provided by Kiplinger
Once you've selected the best structure and your company is growing, periodically evaluate whether the structure still suits your company's needs. You might want to change the structure because of:
- the need to raise additional capital for business expansion;
- a change in tax laws;
- increased risk due to additional dealings with creditors, suppliers or consumers;
- a shift in the business plan that affects the distribution and use of earnings and profits;
- an opportunity to develop a new technology, either in conjunction with others or under the umbrella of a separate but related subsidiary or a research-and-development partner;
- the retirement, death or departure of a founder;
- the need to attract and retain additional top management personnel; and
- mergers, acquisitions, spin-offs or an initial public offering planned for in the near future.
These situations arise as a business grows and evolves. In this example, a small retail business starts out as a sole proprietorship. Once the store is open and running, the owner decides to share ownership with a key employee; the business becomes a general partnership. Eventually they need to remodel, so they bring in a passive investor to help with the cost; the business is now a limited partnership. Let's say sales increase, prompting the hiring of new employees. The two general partners and the limited partner incorporate to better protect the assets of all partners against claims and liabilities of third-party creditors, but they choose to become an S corporation to preserve "pass-through" tax status. When they open a second store, their attorney advises the three owners to form two additional corporations, one as a parent "holding company" and one for the operations of the new store. This prevents creditors of one store from trying to proceed against the assets of the other store. This structure also becomes helpful when a fourth individual is offered shares in the second store -- to raise capital -- but not equity ownership in the first store. Finally, two years later, the owners consider growth through franchising, and they form an LLC to handle the franchise operations. An LLC will also better insulate the assets of the two company-owned stores from possible claims down the road by a disgruntled franchisee.
Making the best business-structure decision early could promote savings for you and avoid the unnecessary expense of converting to another structure down the road. For these reasons, if you are just starting a new business venture, consult with qualified legal and tax advisers prior to making a decision.
Andrew J. Sherman, a nationally recognized corporate and transactional attorney, has spent over two decades as a legal and strategic adviser to hundreds of entrepreneurs and growing companies. He is a senior partner of the Katten Muchin Zavis law firm in Washington, D.C. and chairs its local corporate and technology department. Sherman is also an adjunct professor at the University of Maryland and Georgetown University, where he teaches entrepreneurship and business planning.
