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Why Divide Your Business Into Separate Entities?

Congratulations, first of all.  It sounds like you’re having a bit of success.  This is the kind of question that often comes up when you have a moment to realize that your business is no longer on the first rung of the ladder.  The reasons for dividing your business into several business entities are much like the reasons you had to select a particular form of business in the first place.  Just as you did then, consider how 4 big issues interact with one another:

  • Taxes
  • Liability protection
  • Management structure, and
  • Transferability

The different parts of your business — the sit-down restaurant, the mobile food truck and online sales of your signature BBQ sauce, for example — may have very different strengths, potential for liability and likely futures.  This may be the time to consider a more sophisticated business structure that recognizes these differences and protects the enterprise as a whole.

Tax Issues

Many startups begin as sole proprietorships or general partnerships.  They’re easy to form and the pass-through nature of taxation may make sense for an enterprise where initial small profits are likely to be re-invested in the business immediately.  The double level of taxation for a corporate entity seems like a correspondingly terrible idea.  LLCs may choose to be taxed as partnerships rather than corporations. But now, your business has grown.  Is it time to take some profits out?

Liability Protection

On the other hand, unlike corporations or LLCs, sole proprietors and general partners have unlimited personal liability for the debts of a business.  General partners are also fully liable for the consequences of business actions taken by all other partners.  That risk may be far too much to stomach for a business that serves food to the public, but somewhat more tolerable for an online sales business.  It might make sense to organize the restaurant and food truck as corporations or LLCs, even if, for other reasons, it still made sense to keep the online sales component as a sole proprietorship. It might also make sense to insure the businesses as separate entities.  Food service risks and order fulfillment risks are different.

What if the restaurant actually owns the valuable piece of real estate on which it sits?  It’s somewhat uncomfortable to have the most valuable asset owned by the riskiest enterprise.  We have been considering dividing the business by enterprise.  Might it make sense, instead, to divide it by function into real estate, management and operations entities?  The liability question may vary somewhat by state.  In Texas, for instance, because it is a “charge order” state,  judgments against the business may only be satisfied through application of receipts, rather than existing assets.

Management Structure

Sole proprietors have the ultimate freedom in business decision making.  General partners share it equally. Exactly how comfortable are you with your partner’s judgment?  In a limited partnership, the general partner makes all the decisions.  In a traditional Subchapter C Corporation, the shareholders elect a Board of Directors that makes decisions.  An LLC may be either member managed, much like a general partnership, or manager managed, much like a limited partnership.  This only scratches the surface of possibilities.

Management freedom is only one part of the equation.  Investors may prefer a management structure in which they have some control.  As a business owner, you may want to establish credit for your business that is separate from your personal credit.  This may be easier with a corporate (including LLC) business entity.

Transferability

This includes succession planning, as well as the possibility of stock or asset sales.  Some forms of business are easier to transfer than others.  If you want to run the restaurant well into your dotage, then leave it to your kids, but are considering franchising the food trucks and selling the bottled sauce business to make a quick buck to finance expansion of the restaurant, it might be worth separating them into independent business entities, and structuring each to maximize profit.  Perhaps you don’t want to sell the whole business immediately, but transfer control of an increasing interest as certain benchmarks are achieved?

Dizzy?

Sorry, too many questions.  The  point of this exercise is that, now that you are actually on your way up the ladder of success, you should revisit the issue of structure  with your business attorney to plan for the rest of the climb.

Nasir Pasha, Esq.

Post by:

Managing attorney and co-host of podcast Legally Sound | Smart Business

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