Starting a business is sort of like having a child. You’re there when it enters the world, you watch it grow through the years, and taking care of it is hard work. The first years are often difficult and may be full of sleepless nights, but the experience can be extremely rewarding. And there are more surprising similarities between the two. Sometimes children and businesses are created accidentally (it’s true).
But of course, children are not businesses and businesses are not children (though, yes, businesses sometimes are considered legal “persons” under the law). While children are always blessings, a prospective business owner really shouldn’t create a new business without planning or consulting with specialists. Business formation requires that a prospective organizer carefully think about unique legal, economic, personal, and business considerations, such as the pros and cons of forming a business and of different types of businesses.
In this article, we will provide descriptions of the types of businesses you can form in Arkansas and a general overview of the legal considerations you should keep in mind in starting a new business in Arkansas. And though this article provides general tax considerations for each business type, we do not specialize in tax law and recommend that potential organizers direct their questions about tax matters to an accountant.
Types of Businesses
A sole proprietorship can have only one owner—yourself. When you do business as a sole proprietor, there is no separate business entity; all business is conducted in your name. However, you can file a form with the Secretary of State allowing you to use a name for the proprietorship other than your own name. Because only you can be the owner or member of your sole proprietorship, this also means you are personally responsible for all debts of the sole proprietorship.
- Very simple structure and easy to form.
- Owner is personally liable for all business debts.
- Do not need to file any forms to create a sole proprietorship.
- Though accounts don’t usually recommend it, can intermingle personal and business funds.
- Only have to pay personal income tax and can usually deduct business losses.
- Record-keeping and tax preparation is usually inexpensive.
- Only have equity contributions of a single owner.
- Can lead to tricky estate issues (e.g., if the owner passes away, may be hard to agree on the fair value of the business).
General partnerships are dangerously easy to form; all it takes is two or more people carrying on a business and sharing profits for a general partnership to be created. You do not have to file a specific form to create a general partnership. Though sole proprietorships also do not require that a form be filed, one must be more cautious about accidentally forming a general partnership because general partnerships are subject to more laws and rules than sole proprietorships.
- Easy to form, do not need to file forms to create.
- All general partners are personally liable for business debts.
- Partners only have to pay personal income tax and can usually deduct business losses.
- Record-keeping and tax preparation is generally inexpensive.
- Cannot have passive investors.
- May be difficult for the partnership to continue or transition when a general partner quits.
- Partners must pay taxes on all money earned in any given year even if the money was not distributed to them that year.
- Each partner’s income is subject to employment taxes.
Limited Liability Partnership (LLP)
Not to be confused with LPs or LLLPs (see below), an LLP is basically the same as a general partnership. The major difference is that LLP general partners are not subject to personal liability for the debts of the partnership. This makes the LLP an attractive, informal type of business.
- Same considerations as for general partnerships, except that general partners generally are not personally liable for the LLP’s debts.
Limited Partnership (LP)
Unlike general partnerships and LLPs, limited partnerships (or LPs) have two types of partners: 1) general partners and 2) limited partners. General partners usually control management of the LP while limited partners generally act as passive investors in the partnership.
- Partners only have to pay personal income tax and can usually deduct business losses (though deducting losses may be more difficult for limited partners).
- At least one partner (a general partner) must be personally liable for partnership debts.
- Taxes can sometimes be structured to avoid employment taxes.
- Can have passive investors.
- The partnership can smoothly transition when a limited partner quits, but may not transition as easily if a general partner quits.
Limited Liability Limited Partnership (LLLP)
Just as an LLP is a slightly modified general partnership, an LLLP is also a slightly modified LP that makes all general and limited partners safe from personal liability for the partnership’s debts. The LLLP is one of the newest business forms nationwide, which means that many states do not recognize the LLLP as a legal business entity.
- Same considerations as for LPs, except that both general and limited partners generally are not personally liable for the LLLP’s debts.
- Also, out-of-state courts may not recognize LLLPs conducting business in their state and may find that the LLLP is an LP or some other form of partnership instead.
Limited Liability Company (LLC)
LLCs used to be the newest form of business but are now commonplace nationwide. The LLC business form was designed as a flexible hybrid form that mixes the strengths of both partnerships and corporations. It is therefore a very popular business form.
- Can be more expensive and time-consuming to form.
- Generally, neither members/owners nor managers are personally liable for the LLC’s debts.
- Members/owners only have to pay personal income tax and can usually deduct business losses (unless there are more than 500 members).
- Usually taxed as a partnership but can elect to be taxed as a corporation.
- Flexible management structure that can be made to resemble corporate or partnership structures.
- Members must pay taxes on all money earned in any given year even if the money was not distributed to them that year.
- Members’ income may be subject to employment taxes.
- Accounting can be more expensive than for any other business type.
- Arkansas LLC law is somewhat muddled and unclear.
The corporation is one of the oldest business forms and is, without a doubt, the best type of business for those seeking public investors. However, corporations are arguably the most formal type of business and require extensive recordkeeping, an organized structure, and regular meetings, which some may find not to their taste.
- Formal and inflexible.
- Unlike with LLCs, corporate law is well understood and very clear.
- Passive investors (shareholders) have well-defined rights.
- Shareholders, managers, and directors are generally not subject to personal liability for the debts of the corporation.
- Preferred business type for pulling in outside investment.
- Though small private corporations can be great for some, the corporation is not always a good business type for small and start-up enterprises.
- Corporate income is generally taxed twice, first as corporate income and then as personal income distributed to shareholders.
However, smaller corporations can sometimes elect to avoid corporate taxation.
For most of these business types, there are lots of formal rules for proper formation, and, as with any area of law, there are exceptions to many of the rules. Therefore, as mentioned earlier, it is a good idea to consult with a lawyer, an accountant, and other specialists before forming a business. Let us worry about the technicalities while you enjoy watching your business sprout and grow!
- Professor Carol Goforth, University of Arkansas School of Law, Business Planning: Introduction (2017) (previously referenced material from Business Lawyering Skills class).
- Secretary of State Website
- Arkansas Small Business Center and Technology Development Center