Tuesday, September 29, 2009

Legal Assessments: Fundamental Value of a Separate Legal Business Structure – Part I

Almost anyone starting a business activity considers the formation of some sort of legal business structure such as a limited liability company, a corporation, or a limited partnership.  Generally, the most important reasons for doing so cited by business owners is the limited liability afforded to the owners for activities engaged in by the business entity.  Another factor in selecting a business structure is getting the best tax treatment for the activities in which the business will be engaged.  However, while these issues are key, the creation of a separate entity has advantages related to the simple fact that it is a separate entity.

Sole Proprietors and General Partnerships

Before addressing the value of a separate entity for conducting business, remember that anyone can conduct business without creating a separate entity.  A person selling goods or services as an individual is a sole proprietor, and two or more persons working together to sell goods or services is a general partnership.

The essence of such a business is that the person or people are the business.  Such persons are personally liable for their activities when doing business because their business activities are personal activities. 

Contrast a Business Entity

Chess Piece (small) In contrast, a person who forms a legal entity for their business activities is wearing two different hats depending on what they are doing and how they represent themselves.  When going to the mountains for a vacation, they are personally responsible for their activities and can do things the way they personally prefer.  But when they conduct business as the entity, they must maintain the business persona and act as the business entity.

The advantage of acting as a separate entity is that one can build the business apart from personal issues.  Personal preferences or values still can, and should, impact the business activities, but the impact and implications of applying preferences and values is different.  For example, a personal preference to discriminate against a legally protected class of persons is unacceptable in business activities, whereas the same discrimination in private life is acceptable, even if there may be a social stigma attached.

Key to this distinction when creating a business entity is the way that the law views a business entity as a legally established and supported structure engaged in commercial activities with the public.  In other words, the law recognizes that the a business entity is a special social structure and that the relationships are different.

Some Advantages to Treating the Business Entity Separately

Besides tax status, one primary advantage to treating business entities as distinct is the ability to create systems and structures within the business that perpetuate the goals and values of the business.  The business can be worked on apart from changing personal lifestyles or activities.  Work can be broken down into discrete activities that can be systematized and formalized.  This allows principals to find people who can do the jobs necessary to keep the business going without over-committing themselves, being limited by their particular skills or talents, by their own time constraints, or having to always be be the producer.

In addition, treating a business separately from personal life helps to build a corporate culture.  Corporate culture can be instilled and reinforced by the policies and procedures of the company, its goals, products, or services.  One business can have a techy orientation, another can be environmentally oriented, and yet another can be kid friendly.   These cultures can exist apart from the particular orientations of the owners, principals, shareholders, members, or employees.

Bridge to Sea (small) Finally, creation of a separate entity for business activities expands the founder’s influence to “change the world”, and creates a legacy.  No longer is the influence of the business person limited to their personal activities and capacities, they can create a business institution that independently operates to provide an income stream, provides jobs and livelihood for others, increases productivity and value for society, and influences society according to the values and goals established within the business entity.

The bottom line is that a business entity is an institution apart from those persons who form or operate the entity.  This gives the entity a “life of its own” that creates value.  When done well, it allows the entity to become a commodity that can be bought, sold, trademarked, and an independent source of revenue.