by Richard Stim

Choosing the Right Form for Your Business

BUSINESS FORMS 101

If you’re unclear about the different types of businesses, they include: • Sole Proprietorship: one person owns and runs the crafts business and is personally liable for business debts. • Partnership: two or more people operate the crafts business sharing expenses, responsibilities and profits. Each partner is personally liable for all partnership debts. • Corporation: one or more craftspeople owns shares in the corporation and is shielded from personal liability. • Limited Liability Corporation (LLC): one or more persons creates an LLC that shields member-owners from personal liability. Many crafts businesses also operate as cooperatives. As we discussed in the April issue of The Crafts Report (“Legal Considerations for Starting a Co-Op”), cooperatives — depending on state law — must operate as a partnership, corporation or LLC.

Valerie Stainton had always dreamed of opening a crafts gallery. One day, she took the plunge, gave notice to her employer of 22 years and leased space for Valerie’s Gallery in nearby Newburyport, Mass.

One of Stainton’s biggest concerns was how to structure her enterprise — that is, as a sole proprietorship, partnership, corporation or limited liability corporation (LLC). She knew something about business — she had been the business manager at her former job — and learned more from reading books and researching on the Internet (one helpful source was Service Core of Retired Executives at www.score.org).

With the help of an attorney, she decided to form an LLC. “I’m a conservative person,” says Stainton, “and one of [the LLC’s benefits] is the protection of personal assets.” In other words, Stainton was concerned that without an LLC a creditor could attempt to collect a business debt by reaching into her personal bank account or going after her house.

Shield yourself from personal liability

Forming an LLC or a corporation will shield you from personal liability, but is it the right choice for your crafts business? In this article, we’ll discuss ways to limit personal liability.

Before talking about how to limit liabilities, let’s define what liabilities are. Liabilities are basically debts — money you owe. Every business carries some liabilities, such as ongoing payments to suppliers, rent for your studio, compensation to employees or booth fees at a show. Additional liabilities may arise if your business is devastated by a fire or flood or if you are the victim of a lawsuit — for example, someone’s injured in your studio and sues you for damages.

If you operate your business as a sole proprietorship (the most common business form for crafts businesses), you are personally liable for all business debts. The same is true for a partnership. A creditor can collect a partnership debt against any partner, regardless of which partner incurred the debt. For example, if your partner orders $50,000 worth of supplies (without telling you) and then moves to Venezuela, you could be on the hook. A written partnership agreement can apportion liability among partners, but it won’t absolve you of personal liability.

Corporations and LLCs are created to shield you from personal liability. This means that even if your business declares bankruptcy, creditors cannot seek your personal assets as payment for those business debts. In short, if you operate as a corporation or LLC, creditors can — with rare exceptions (see sidebar, “When the Corporate Shield Can’t Protect You”) — only collect their debts from the business’ assets, not the owner’s personal property.

WHEN THE CORPORATE SHIELD CAN'T PROTECT YOU Your corporation or LLC cannot always protect your personal assets, for example, you won’t be shielded if: • You are negligent or careless in a way that’s unreasonable. For example, you’re running with a case of pottery and drop it on a customer’s foot. • You sign a guarantee promising to be personally liable for a debt.

But that’s not to say you should rush out tomorrow and convert your sole proprietorship or partnership to one of these entities. All this protection comes at a price. To acquire corporate or LLC status, you need to pay fees and file paperwork with your Secretary of State. For example, Stainton paid $750 in legal fees and $585 in state filing fees. (You can cut these fees by preparing your own filing — see Resources.) But LLCs and corporations still require legal attention. Stainton’s LLC was formed in New Hampshire (where she resided) but she then filed a foreign corporation statement in Massachusetts, permitting her to do business there. (She would have filed her LLC in Massachusetts but it is the only state that requires an LLC have at least two owners; every other state allows you to form it with one.)

Many crafts businesses operate comfortably as sole proprietorships or partnerships because they have limited their liability in other ways. For example, you don’t need to bother forming an LLC or a corporation if:

• You maintain adequate insurance and are not subject to risk in areas where insurance is inadequate.
• You don’t expect your business to be running up substantial debts.
• You don’t need to personally guarantee loans.

RESOURCES

• Score (www.score.org) is an organization in which business volunteers donate their expertise as e-mail counselors to entrepreneurs. • Nolo (www.nolo.com) is a self-help law center with information on business forms, books and software to help you form an LLC or corporation. • Quicken Lawyer Business is business software that offers advice and explanations for forming a business and many contracts (including a partnership agreement).

The importance of adequate insurance

Adequate insurance is particularly important protection against business disasters such as fire, theft, injury to visitors, workplace injuries, injuries resulting from the use of your crafts goods and even claims that you stole someone else’s design. Some of this insurance is mandatory — state laws require that you obtain workmen’s compensation insurance, or a lease requires that you acquire business and personal property coverage. Other insurance may prove cost-prohibitive. Generally, you can sufficiently limit your liability if you:

• Maintain enough property and liability coverage to protect yourself from common claims. These are the most important kinds of insurance for a small business.
• Buy insurance against serious risks (if the insurance is reasonably priced).
• Keep insurance costs down by selecting high deductibles.
• Do your best to reduce hazards or conditions that can lead to insurance claims.

Before making your final decision about a business form, keep in mind that the tax rules for sole proprietorships, partnerships, corporations and LLCs are different. Seek advice from your accountant before choosing any of the entities for your business. (In
next month’s column we’ll discuss how these different business forms are taxed.)