Overview

Starting a Minnesota business also includes choosing the form of that business. This is an important part of any process of business formation. The business form you choose may have lasting financial, governance and tax implications for the owners. You may choose to incorporate or to form an LLC. However, your choice may have a lasting impact on the business' legal and financial circumstances.

When starting a Minnesota Business, you have the following business options:

(1) sole proprietorships;

(2) partnerships;

(3) Minnesota limited partnerships;

(4) Minnesota limited liability companies;

(5) Incorporating as a subchapter S corporation -- (Minnesota closely held corporations ); (6) Incorporating as a C corporation. (C Corp)

Sole Proprietorships

Sole proprietorship is the simplest form of business ownership. You are a sole proprietor if you are the sole owner of your business. A sole proprietorship does not require any filing with the State to start operating the business. However, there are some serious drawbacks to this form of business ownership.

First and foremost, a sole proprietorship affords the least amount of asset protection to the business owner. Anything you do as a sole proprietor may expose your personal assets to garnishment or liens based on the debts or actions of the business enterprise. There are manty other business forms including LLC's, and incorporations that provide limited liabilty as part of their protections.

General Partnerships

A general partnership may carry even more risk than the sole proprietorship as a business form. It is generally not recommended over the LLC and/or minnesota incorporation.

A general partnership is formed when there are two or more owners of a business. Again, this form of business also does not require any filing with the state. If you start a business with a partner without completing any forms or agreements, you would be considered a General Partnership.

Like a sole proprietorship, the personal assets of the owners are subject to liens and garnishments for acts performed on behalf of the business or debts incurred for the business. Even more significant, anything that one partner does affects all of the partners. That means each partner is personally responsible for all obligations of the partnership.

Often, we are presented with business disputes that arise from the general partnership where no agreements have been executed which define exit strategies, succession ownership or partner buy-outs. Most people who enter into general partnerships never expect that at some point they may disagree with their partner(s) on business strategies, or business efforts. This may result is serious conflict.

Even more vexing, if one partner dies and agreements do not exist to purchase that partners interest, the remaining partners may find themselves in partnership with a wife or other relative with whom they have conflict. If you need legal contracts to govern your business, contact us at 952.746.2153. Avoid disputes before they start.

The remaining business forms (incorporations, LLC's and Limited Partnerships) limit personal liability for activities arising out of business. Each requires that formal business documents are filed with the state and that the business identity is maintained.

Limited Partnerships

A Limited Partnership ("LP") is an association of individuals, some of whom participate in the day to day operations of the business and others who do not participate.

LP's are often created when one or more owners provide the financing ("limited partners") and the other owners provide the operational expertise of running the business ("general partners").

There are several important characteristics that distinguish an LP from general partnerships or sole proprietorships. First, a filing with the State is required to create a LP. Second, the ownership interests of the partners cannot be freely transferred or sold without filing additional documents with the state and perhaps subject to additional limitations placed into partnership agreements. Partnership agreements are critical to determine exit strategies and succession planning in a Limited Partnership. For a consultation on these issues call 952.831.5000.

The most important feature of a LP is that any limited partners (those not actively involved in the day to day operations of the business) are not personally responsible for the negligent acts or debts of the business. This is called "limited liability."

By contrast, any general partner (one who participates in the operation of the partnership business) does not have limited liability and may be responsible for business obligations placing the general partner's personal assets at risk. Contact us at 952.746.2153 to form your Limited Partnership.

Limited Liability Companies

Limited liability companies ("LLC") combine many of the advantages of a partnership with the advantage of a corporation's limited shareholder liability.

Each member of an LLC is protected from the business' financial responsibilities. Even more interesting is that, in an LLC, governance rights - the right to control the operations of the business - may be separated from ownership rights - the right to share in the increased value of the business. That means that an LLC member may own 50% of the value of an LLC, but have less or more than 50% control of the business as determined by LLC documents. This flexible format is ideal for accommodating distinctive arrangements agreed to by LLC owners during business negotiations.

The advantages of the LLC may be summarized as follows:

(1) Limited liability protection;

(2) No restriction on the number of owners (called "members" in an LLC);

(3) "Pass through" taxation. That means that any business losses may be written off by the individual business owners or profits reported by individual business owners at their individual tax rates;

(4) Avoidance of the double taxation that characterizes "c" corporations;

(5) Freedom from many of the legal formalities that govern corporations such as annual reports and directors meetings;

(6)Flexibility in the governance and ownership structure.

To create an LLC, members file articles of organization with the state and pay filing fees ($135 in Minnesota). LLC members should also have operating agreements which set forth the rights to governance - that is the management and operation of the business on a daily basis. Contact us at 952.746.2153 to form your LLC.

Minnesota Corporations (Incorporation)

A common definition of a corporation is that it creates a fictitious or artificial person. For legal and tax purposes, a corporation is a separate entity from its owners, an entity that can make purchases, enter into contracts, must pay taxes, and can sue and be sued on its own behalf. As a result, correctly incorporating in Minnesota can make a big difference in the exposure of company owners and officers to liabilty for various expenditures on behalf of the corporation.

All too often, incorporations are not carried out correctly. Instead, only the most rudimentary documents like Articles of Incorporation are filed. this provides little protection if corporate formalities regarding corporate governance are not followed. It becomes even more complicated when you realize that there are two very different types of corporations.

The two types of corporations that exist are the "C" corporation and the subchapter "S." A "C" corporation is one that is publicly held. It usually has a large number of individual owners. The main drawback of a "C" corporation is the tax treatment of the business. A "C" corporation is subject to double taxation. What that means is that any profits of the company are taxed at corporate levels when they are realized by the corporation and taxed again at individual tax rates when distributed to shareholders.

A subchapter "S" corporation may also be referred to as a "closely held corporation." There are certain requirements which must be met to qualify as a subchapter "S" corporation. To be treated as a subchapter S corporation under federal tax laws, the corporation:

(1) Must be a domestic corporation (not foreign);

(2) Must not be part of an affiliated group of corporations;

(3) Must not have more than 35 shareholders;

(4) Must have only one class of stock ;

(5) Must have only shareholders who are individuals, a decedent's estate, or one of a special class of trusts (not corporations or partnerships);

(6) Must have no shareholders who are nonresident aliens.

After a business has incorporated, all shareholders must consent to Subchapter S treatment. The election to be treated as a Subchapter S corporation must be filed with the Internal Revenue Service in a timely manner. Further, the profits and losses of a subchapter "s" are passed on to shareholders and are not subject to double taxation that characterizes the "C" corporation.

Becoming a corporation gives a business several advantages over other forms of business organizations such as sole proprietorships or partnerships. One of the advantages is "survivability." Since a corporation is an artificial person, its existence does not depend on who its owners are at any given time. A corporation can survive the death of an individual shareholder or director or the transfer of shares. The corporation "dies" only when it is dissolved. This permanence of operation allows corporations to raise funds by selling shares to new investors since new owners may be added without disturbing the corporate form.

Owners (shareholders) of corporations also enjoy "limited liability". The corporation can be sued in its own name. As a result, the shareholders are not personally liable for debts the corporation is unable to pay or for the negligent acts of corporate employees. It is important to remember, however, that it may be difficult for a new corporation to acquire loans in its own name early in its existence. Young corporations have not yet established independent credit worthiness. As a result, most banks and other lenders may require personal indemnifications from shareholders for the debts of new corporations.

To maintain limited liability status, a corporation must follow corporate formalities. That means the business must hold itself out to the public as a corporation. All letterhead and business cards should designate the business as a corporation. This puts the public on notice that they are dealing with a limited liability entity. Additionally, corporations must maintain separate bank accounts from those of its owners. A failure to keep separate accounts may blur the corporate identity with the identity of the individual shareholders exposing personal assets to corporate liabilities. This is called "piercing the corporate veil."

In Minnesota and Wisconsin, piercing the corporate veil is extremely rare. Courts use a two-prong test in order to determine whether to ignore a corporation's status and expose shareholders to corporate liabilities. The first prong of the test analyzes the shareholders' relationship to the corporation. Some questions that a court may ask include:

Was there sufficient capitalization to carry on the corporate business?

Did the shareholder follow corporate formalities such as conducting regular meetings, electing directors, and keeping separate accounts?

Have proceeds of the corporation been siphoned off to shareholders?

There are numerous risks associated with forming a corporation. It is always wise to seek legal advice.