Part of the Recording Studio Business Plan needs to include how your business will be structured, in other words, what form of ownership will your business will take; Sole Proprietorship, Partnership, Corporation, SubChapter S Corporation and Limited Liability Corporation (LLC).
Sole Proprietorships Most businesses start out as sole proprietorships. This means that the business is owned and operated by one person, usually the person who has the day-to-day responsibility of running the business. Sole proprietors own all of the assets of the business, all of the profits and are also responsible for all of the liabilities and/or debts. In the eyes of the law, the sole proprietor and the business are one and the same.
The Pros of sole proprietorship are:
It is the easiest and least expensive form of ownership
The owner is in complete control to make decisions as they see fit, as long as they stay within the parameters of law.
Owners receive all of the income generated by the business to keep or reinvest.
Profits are handled (with a Schedule C) on the owner’s tax return.
The business is easy to dissolve.
The Cons of sole proprietorship:
Owners have unlimited liability and are legally responsible for all debts against the business. Business and personal assets are at risk.
Owners have a hard time raising funds and are often limited to using funds from personal savings or consumer loans.
Some employee benefits, such as medical insurance premiums are only partially deductible as an adjustment to income.
In a partnership, two or more people share ownership of the business. Just like the sole proprietorship, the law does not distinguish between the business and its owners. Partners should have a legal agreement that establishes the parameters of the business; how decisions will be made, how profits will be shared, disputes resolved, how future partners may be admitted into the partnership, and what steps will be taken when the partnership needs to be dissolved. Partners must also decide up-front how much time and capital each will contribute, etc.
The Pros of Partnership are:
Partnerships are fairly easy to establish, however time should be invested in developing a Partnership Agreement.
When more than one owner, the ability to raise funds is increased.
The profits from the business flow directly through the partners’ personal tax returns.
The business will benefit from partners with complementary skills.
The Cons of Partnership are:
Partners are jointly and individually liable for the actions of the other partners.
Profits are shared by all partners.
Shared decisions cause disagreements and in-fighting.
The partnership may have a limited live and may end upon the withdrawal or dearth of a partner.
Types of Partnership to be considered:
General Partnership means partners divide responsibility for management and liability as well as the shares of profit or loss according to the partnership agreement. Equal shares are assumed unless the partnership agreement states differently.
Limited Partnership & Partnership with limited liability means that most of the partners have limited liability (to the extent of their investment) as well as limited input regarding management decisions. This form of ownership is not often used for operating retail or service businesses. Forming this type of partnership is more complex and formal than that of a general partnership.
Joint Venture, this type of agreement acts like a general partnership, but is clearly for a limited period of time or a single project. If the partners in a joint venture repeat the activity, they will be recognized as an ongoing partnership and will have to file as such as well as distributed accumulated partnership assets upon dissolution of the entity.
Corporations A corporation is chartered by a state in which it is headquartered and is considered by law to be a separate entity, apart from those who own it. A corporation can be taxed, it can be sued and it can enter into contract agreements. The owners of a corporation are its shareholders. The shareholders elect a board of directors to oversee the major policies and decisions. A corporation has a life of its own and does not dissolve when the ownership changes.
The Pros of a Corporation are:
The shareholders have limited liability for the corporation’s debts and/or judgments.
Generally shareholders can only be held accountable for their investment in the stock of the company.
Corporations can raise additional funds through the sale of stock.
A corporations may deduct the cost of benefits it provides officers and employees.
The Cons of a Corporation are:
The process of incorporation requires more time and money than other forms of organization.
Corporations are monitored by federal, state and some local agencies, and as a result may have more paperwork to comply with regulations.
Incorporating may result in higher taxes. Dividends paid to shareholders are not deductible from business income, and can be taxed twice.
Subchapter S Corporations This type of corporation is a tax election only. An S Corporation enables the shareholder to treat the earnings and profits and distributions and have them pass through directly to their personal tax return. The catch here is that the shareholder must pay yourself what you would have to pay someone to do your job, as long as there is enough profit. If you do not do this, the IRS can reclassify all of the earnings and profit as wages and you will be liable for all the payroll taxes on the total amount.
Limited Liability Company (LLC) An LLC is designed to provide the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. Formation of an LLC is more complex and formal than that of a general partnership. The owners are members, and the duration of the LLC is usually determined when the organization papers are filed. The time limit can be continued by a vote of the members at the time of expiration.
LLC’s must not have more than two of the four characteristics that define corporations:
Limited liability to the extent of assets
Continuity of life
Centralization of management
Free transferability of ownership interests
Deciding the business structure is a decision that will have long-term implications, so consult with an accountant and attorney to help you select the form of ownership that is right for you. Remember to take into account;
Your vision of the size and goals you have for your studio.
The level of control you wish to have.
The level of business structure you are willing to deal with.
The recording studio’s vulnerability to lawsuits.
Tax implications of the different ownership structures.
Expected profit (or loss) of the recording studio.
Whether or not you need to reinvest earnings into the business
Your need for access to cash out of the business for yourself.
NOTE: Information from SBA Small Business Planner