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Scenario

This Discussion is based on the following hypothetical scenario:

You are a business consultant. Angel and Maris are budding entrepreneurs who are smart, creative, charismatic, and energetic. However, they lack knowledge of business structures or an understanding of how to balance risk and efficiency in organizing a business. They have invented a unique wearable AI app that can be added to a “smart” watch or built into a wrist or ankle bracelet to monitor, track, and analyze the wearer’s pulse/heart rate, body temperature, and blood pressure, and report the data to the wearer’s designated healthcare provider or other third party as the wearer chooses; the AI also analyzes the data over designated time periods and keeps a running comparison to the wearer's history against diagnostic statistics. They are calling this app “MvMe.” Angel and Maris are also working on other innovations. So far, their arrangement has been an informal de facto partnership, using a back room in Angel’s house as a shared workspace. They live in the State of Virginia. But now they realize they need to get serious about their business plan. An investor is interested in funding production and beta testing of MvMe. They want to minimize their personal liability in their business operations. Maris recently read a blog about LLC, C-Corp, and S-Corp structures, but does not know which one would be best for them. They have asked for your advice.  

Discuss!

Consider Angel and Maris’ situation, including stakeholders and likely strategic planning for their business. Which of the following business structures are best for Angel and Maris? 

· LLC  

· C-Corp 

· S-Corp  

For your initial response:

→Recommend one of the above three business structures and explain why it is the best option for their situation; and 

→Summarize at least one (1) business legal risk that Angel and Maris will minimize by organizing their business with your recommended business structure. 

Sole Proprietorship & Partnership

Sole Proprietorship 

A sole proprietorship is a common, traditional form of business operation. Owned and operated by a single individual, it is the simplest form of business structure. Typically, a sole proprietorship is a small business, such as a small shop, one-person repair service, or artist. The benefits are autonomy and simplicity. The sole owner makes all decisions, directly manages day-to-day operations, and retains all profits. On the negative side, the owner is personally liable for all debts, losses, and legal liabilities associated with the business.  

Setting up a sole proprietorship is simple. There are minimal regulatory requirements for the business structure. For a small business engaged in a low-risk activity, it is an attractive option. If a single person does business casually or part-time as an independent contractor without forming a structured formal business for the activities, the sole proprietorship will be the de facto designation. 

General Partnership 

In contrast, a general partnership involves two or more individuals who co-own and operate a business together. Like sole proprietorships, partnerships are relatively easy to establish, but they should have a written partnership agreement to outline terms, profit-sharing, and roles. General partners share equal responsibility for managing the business, profits, losses, and liabilities. Each partner is personally liable for the debts and obligations of the partnership and the actions of the other partners committed in the scope of the partnership.  

The benefits of a partnership are the combined resources and expertise of the partners. Like sole proprietors, partners have unlimited personal liability for the partnership’s debts and actions.  

Unlike a sole proprietorship, decision-making and profits are shared among the partners, enhancing resources and expertise for the business. However, partner dynamics can also introduce conflicts.  

If a partner dies or otherwise leaves the partnership, the partnership automatically ends. The remaining partners can dissolve the partnership or continue as a new partnership.  Or, a partnership of two members can become a sole proprietorship or reform as another type of business structure. Formally structured partnership agreements should provide for death or departure of a partner.

Limited Partnership 

A limited partnership (LP) is a business structure that includes both general partners and limited partners. This structure offers a middle ground between the simplicity of a general partnership and the liability protection found in a more complex entity like a corporation or limited liability company (LLC).

In an LP, a general partner maintains primary control and liability for the business, the same as in a general partnership. Limited partners are passive investors who have less involvement in the partnership operations. They enjoy reduced liability for partnership debts and liabilities, usually no more than to the extent of their investment in the partnership. The obvious advantage is that their investment contributes capital to the partnership, and, in turn, profits and losses pass to them as tax benefits. Beyond the risk of investment loss, the limited partner is not responsible for the partnership debt. That is borne by the general partner. 

Advantages and disadvantages of sole proprietorships and partnerships over corporations or LLCs 

Sole proprietorships and general partnerships require little paperwork and no formal filings to create, though partnership agreements are recommended. They do not involve the filing fees, corporate formalities, and documented meetings to evidence continued corporate existence that are required for corporations and LLCs. Additionally, they are not taxed as entities. Profits and losses of the business are reported on the owners’ personal tax returns. Corporations are taxed separately before profits are distributed, which in turn are again taxable to the owners. 

Establishing a limited partnership involves a bit more paperwork than a sole proprietorship or general partnership, but it remains simpler and less costly than forming a corporation or LLC. 

The critical disadvantage of these structures is the heightened legal risk for owners. Except for passive limited partners (assuming a proper LP agreement has been set up), the sole proprietors and partners do not have limited liability for the debts and activities of the business. In the case of partnerships, if one partner quits or dies, the partnership automatically ends, and the business is wound up. A new partnership must be organized and formalized to continue the business (Fishman, 2022). 

Corporations

A corporation is a legal person. A domestic corporation means the company is “domestic” to the state in which it was incorporated. A “foreign” corporation was incorporated in another U.S. state from its home state of principal business. 

Corporations are organized in various classifications  

C-Corporation 

Unlike sole proprietorships and partnerships, a C-corporation, or C-corp, is a separate entity from its owners, who are shareholders. It continues in business if a shareholder leaves the company or transfers or sells their shares to someone else. Corporations can raise money by selling stock, a benefit to attract investors and employees. The C-corp provides a corporate shield against the personal liability of its shareholders so long as corporate formalities are observed. 

On the other hand, publicly held corporations are traded on a national securities exchange, and shareholders might own a few or thousands of shares. A multinational corporation operates in many nations. A professional corporation’s ownership is limited to members of a profession, such as accountants, doctors, dentists, and lawyers. A not-for-profit corporation is operated for charitable, educational, religious, or similar purposes recognized by law. 

S-Corporation 

S corporations are formed from a C-corp structure by using a tax election that permits corporate income, losses, deductions, and credits to pass through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates ( IRS, 2024 [Gov. website](this link opens in a new window/tab) ). The S-corp classification is created by filing an election with the IRS. There are restrictions: the number of shareholders is limited to 100 people or fewer, including certain trusts or estates. Partnerships, other corporations, or non-resident aliens cannot be shareholders of an S-corp. 

Limited Liability Company

A limited liability company (LLC) is a flexible business structure that combines elements of both corporations and partnerships. An LLC is organized under state law requirements and operated pursuant to a management agreement with a managing member. 

Owners, called “members,” are protected from personal liability like shareholders of C-corps but have more flexibility in operations and can be taxed like partnerships, avoiding double taxation.  

Flexibility includes fewer formalities and regulations, no board of directors, and no annual meetings. An LLC can be composed of one or several members, and a member can be another LLC. These are advantages.  

There are some detractors. LLCs are generally not favored by venture capitalists or investors because they do not issue stock and have a loose governance structure. An investor might be more inclined to look at purchasing (taking over) an LLC instead, which cuts out the founding owner(s). Some states require an LLC to dissolve and be re-formed anew if a member leaves the LLC.