of one of the partners, and all partners have unlimited liability for partnership actions irrespective of initiating partner. Most states have minimal requirements for the creation of general partnerships, while limited partnerships typically require only the filing of a one-page certificate of limited partnership.

Advantages

1. Start-up costs are inexpensive.

2. It is easy to establish with two or more entities.

3. Limited registration is required.

4. Partnerships are their own legal entities.

5. Tax treatment is favorable because income and expense flow through to partners.

6. Limited partners liability is normally restricted to their investment (they can become liable if actively involved in the business).

7. Limited partner income is not subject to self-employment tax.

Disadvantages

1. General partners have unlimited liability.

2. Creditors of a general partner can pursue the partnership and force its liquidation.

3. The partnership normally ends when one partner dies or becomes bankrupt (other partners elect to continue under some circumstances).

4. Adding new partners generally requires consent of all existing partners.

5. Limited partnerships have been attractive to passive investors but pose problems for investors (angel investors, venture capitalists, equity funds) who wish to assume an active role in the company.

6. Valuing partnership interests can be complicated.

Limitations of a Partnership

A good example of organizational structure impeding growth is the case of a construction management firm. The firm, a partnership, employed 7 principals (senior and junior partners) plus about 15 others and was managing about $35 million in construction contracts.

Due to the nature of partnerships (unlimited liability of all named partners for any and all partnership liabilities) and bonding requirements (the need for hard assets to secure bonds), taking on larger projects was problematic. Many bonds required personal guarantees from the principals and were often secured by their homes. This led to variations in opinion among the partnership about acceptable levels of risk and pursuit parameters for new projects.

Within nine months, the firm, with the help of an outside adviser, became a corporation. Bank financing for projects was secured. A valuation formula for the company was established, and one partner was bought out. The remaining principals grew the firm to more than $100 million in sales, eventually selling it to a larger company.

Limited Liability Companies

The LLC is a relatively new organizational structure developed to overcome some of the shortcomings of the limited partnership. All members of an LLC are essentially treated as limited partners in relation to liability issues, but with a difference. Creditors of individual LLC members cannot pursue the entity; bankruptcy (bankruptcy and assignments for the benefits of creditors terminates membership) or the death of a member does not necessarily force its dissolution. A well-thought-out operating agreement explaining all rights and remedies is critical to the LLCs success.

Advantages

1. LLCs can be created by one or two members (individuals, corporations, other LLCs) depending on state law.

2. Most states require the filing of a single-page certificate of formation.

3. Members enjoy limited liability status but may be involved in the bus iness.

4. Members have protection from creditors of individual members.

5. Members have interests, rather than shares, which are more scalable in accommodating internal growth.

6. LLCs may not offer options.

7. Flexible handling of ownership interests, distribution rights, voting r ights, income distributions, losses, credits, and deductions can be allocated to members.

8. LLCs can be easily converted to the corporate form.

Disadvantages

1. Adding new members requires the agreement and consent of all existing members (unless provided for in the operating agreement).

2. LLCs are not true corporations and lack case law to support a full range of activities.

3. Interests do not provide for awarding of employee options or stock.

4. LLCs may restrict investment options if outside capital is sought, except in cases of foreign investment where the LLC is a familiar structure.

Subchapter S Corporation

A popular structure for many professional services firms is the subchapter S corporation (S-Corp). The S-Corp has been in existence for many years, and its corporate structure provides well-defined case law in support of the r ights of officers, directors, and shareholders. In addition, it allows income and losses to pass through to the individual shareholders. The S-Corp follows the corporate form of the subchapter C corporation (C-Corp) in many ways but without the imposition of a second level of taxation. It has, however, some restrictions such as limitations on the number of shareholders and restrictions on who can own shares. Some of these restrictions have been eased by recent legislation.

For example, S-Corps are no longer limited to 35 shareholders. Under the new regulations, that number has been increased to 75. Stock ownership has also been relaxed. Currently, other corporations can own shares, as can pension plans, stock bonus plans, and profit sharing plans. The new regulations also allow S-Corps to provide stock incentives to employees.

Some restrictions still remain, including restrictions on employee benefits allowable to large shareholders. The S-Corp may still have only one class of stock. Foreign investors are not permitted. Only small business corporations are allowed to elect S-Corp status. While conversion to a C-Corp is possible, conversion to an LLC requires that the corporation be dissolved, leading to potentially adverse tax implications.

Advantages

1. S-Corps have a proven corporate structure.

2. S-Corps have a favorable tax treatment similar to partnerships.

3. Liability protection and regulations as in the corporate form apply.

4. Regulations were recently liberalized.

a. S-Corps can now have up to 75 shareholders.

b. Ownership is now open to other corporations and nonprofits.

c. S-Corps can own subsidiaries.

d. S-Corps can provide stock incentives to employees.

Disadvantages

1. Only one class of stock is allowed.

2. S-Corps are available only to qualified small business corporations.

3. Foreign investors are not permitted.

4. The form restricts investment options.

5. Employee benefits are limited for large shareholders.

6. Conversion options to LLC may trigger unwanted tax implications.