The Forms of Business Ownership in Michigan

I’m confused by the many different forms of business ownership; can you run through them and give some of their basic characteristics?

Certainly.  The basic entities to run a business are:  sole proprietorship, partnership, corporation, limited partnership, and limited liability company.

A sole proprietorship is an individual who runs his own business.  Everything is done in his own name:  he forms contracts, hires employees, purchases supplies, etc.  He is not required to file anything with anybody to start or run the business, although he may need to file a certificate of assumed name (a “DBA” certificate) with the county if he conducts business under any name other than his own.  The only additional paperwork is the filing of a Schedule C with his tax return.  The drawback to running a sole proprietorship is that the individual is personally liable for everything he does.  If the business is at medium or high risk for injury (e.g., lawn mowing, skydiving), the owner would be better off using another form of business ownership.

A partnership is two or more persons who conduct business together.  Persons conducting business as a partnership should file a certificate of co-partnership with the county or counties in which they conduct business, although filing the certificate is not a prerequisite to the formation of a partnership. Formation of a partnership does not require any special intentions or any written agreement (although a written agreement about the nature of the business, who does what, and what happens when one or more parties want to dissolve the partnership is strongly suggested) and can be formed inadvertently simply by two persons conducting business jointly.  Each partner is fully liable for partnership debts, even if they were not aware that their partner incurred the debt.  Because of these two attributes, a partnership is usually the worst form of business ownership and should be avoided.

A corporation is the original of the so-called “statutory” entities:  a corporation does not exist unless Articles of Incorporation have been filed with the Michigan Department of Consumer and Industry Services (“CIS”).  Once filed, a corporation has an existence separate from the person or persons (called shareholders) who invest in the corporation.  The shareholders elect one or more directors who set the policy for the corporation.  The directors in turn elect officers who run the day-to-day operations of the business.  The main advantage of incorporating is insulation of shareholders, directors, and officers from personal liability of the debts of the corporation:  these persons generally are not liable for the debts or liabilities of the corporation in the absence of fraud.  A corporation’s existence is recognized by other states and most other countries, although other states and countries may require the filing of documents with their version of CIS before allowing a Michigan corporation to conduct business in that state or country.  The biggest drawback of incorporating is the double taxation:  corporations are taxed on their income and must file a corporate tax return.  Distributions of corporate profit to shareholders (“dividends”) are taxed a second time as income to the shareholders.  This can be avoided in some circumstances by filing a “subchapter S election” with the Internal Revenue Service, but such an election is beyond the scope of this article.

A limited partnership is also formed by filing a Certificate of Limited Partnership with CIS.  A limited partnership consists of one or more general partners, who run the business and are fully liable for the partnership’s debts, and one or more limited partners, who have limited say in the conduct of the business, but have the power to remove the general partners and to receive distributions of partnership income.  Limited partners generally are not liable for limited partnership debts.  The main use of a limited partnership is to raise capital to start or expand a business:  the general partners may have the business idea and/or the expertise to operate the business but insufficient funds; they sell the limited partnership interests to persons who may have no expertise in the business but are looking for a return on their investment.  The general partner need not be an individual; it can be a corporation or even another limited partnership.  A limited partnership may be taxed at either the partnership or the individual partner levels, but is usually set up so that it is taxed only at the individual partner level.

A limited liability company is the new kid of the block; the statute authorizing the formation of limited liability companies was passed in the early 1990s in Michigan.  Like corporations and limited partnerships, a limited liability company is formed by the filing of Articles of Organization with CIS.  The persons investing in and/or operating the business are called members, although the business may also be run by managers.  A limited liability company combines the insulation from personal liability characteristic of a corporation with the taxation at the individual level of a limited partnership.  A limited liability company is an extremely flexible and attractive form of business ownership because of the ease of formation, the relatively small paperwork burden, and the single taxation, but it is not likely to replace the other forms of business ownership anytime soon as there are certain drawbacks.  For instance, a limited liability company is probably not the best choice for an extremely large or diverse business enterprise.  Also, unlike shareholders or limited partners, members owe duties of loyalty, honesty, and fair dealing (“fiduciary” duties) to the limited liability company.

Deciding which form of business ownership to choose is not always easy, as there are many overlapping attributes that make more than one form of ownership amenable to certain businesses.  The explanations in this article are just a brief, general overview of the business forms, and there are many considerations beyond those listed that should influence the decision.  If you are thinking of starting your own business, you should get more detailed information about business ownership forms, either from other written sources or from consulting a professional.

© Steve Sowell 2018