Interestingly enough, if you’ve started a business and engaged in a business activity, you’re already a sole proprietorship. A sole proprietorship is not a legal entity. You don’t have to file any paperwork with the state to start a sole proprietorship, as it already exists the moment you begin operating as a business. This is one of the significant benefits of a sole proprietorship – simplicity.
Although it isn’t required in Arizona, you can register a business trade name with the Secretary of State of Arizona. The trade name, called a DBA (Doing Business As), merely functions to stop other businesses from using your name for their business. It secures that name for your business. Think of it like your business’s name card.
Downfalls of a sole proprietorship
Although a sole proprietorship may look enticing to a small business owner, sole proprietors are personally liable for the debts and obligations of the business. For example, if a sole proprietor borrows money on behalf of the business to expand and is unable to pay back the loan, the sole proprietor is personally liable to pay back that debt. Why? The business and the person are the same thing! This type of personal liability extends to lawsuits as well. If the sole proprietorship is sued, and loses, the proprietor is liable for the judgment. This means that a sole proprietor’s bank accounts, cars, and house are on the line. Personal liability can be the financial downfall of a business and a business owner. For this reason, it’s recommended that small business owners seek the legal protection of a Limited Liability Company or a Limited Liability Partnership.
A Limited Liability Company (LLC)
A limited liability is the most popular option for small businesses. The reasons are simple. Properly organized LLCs are relatively simple to organize, can limit personal liability, and increase tax savings. LLCs can raise capital to help businesses grow as well as enter into contracts with other companies or individuals. When an LLC is well built, it is a flexible legal entity that has become “go-to legal entity” for small businesses. If you have more questions about whether or not an LLC is a viable option for you, I recommend contacting an attorney.
To form an LLC, its member or members must file Articles of Organization with the Secretary of State. When filing its Articles of Organization, an LLC can choose a name that becomes their trade name and public identification.
Within 60 days after being approved for organization, the LLC must then publish a Notice of Publication with a newspaper in three consecutive publications. Don’t worry, this is incredibly simple. Most newspapers charge 40-60 dollars to publish the Notice of Publication for you.
There are some other things you should consider when opening a business. I won’t get into them here, but if you have questions about them, you should contact an attorney.
- Does your business activity require licenses and/or permits?
- Do you need a specific type of insurance or general liability insurance?
- How do I set up a business Bank Account or register for an employer identification number (EIN)?
What if I’m in Business with Someone Else?
Whenever two or more legal entities or natural persons are members of an LLC, it’s critical that the members enter into an operating agreement with one another. An operating agreement is not filed with the state. Rather, it’s an internal document that’s a contract between the members. It outlines the relationship between the members of an LLC. A LLC’s financial and structural decisions can be governed by a well-constructed operating agreement. They oftentimes cover issues like distribution of profits, losses, and voting rights and responsibilities can be governed by an operating agreement.
An operating agreement can help members avoid ongoing internal conflicts that impede business operations. In the event that a conflict arises between the members, a well drafted operating agreement can the members resolve the conflict and move on. It’s like the Constitution of an LLC. It’s the document members can refer to in moments of uncertainty that governs internal operations.
It’s important to know that each state has default rules that govern LLCs that don’t have an operating agreement (or in the case of a partnership, a partnership agreement). Without an operating agreement, an LLC (or partnership) is at the mercy of a state’s default rules. Why wouldn’t an LLC want this? A state’s default rules may run contrary to how all the members in an LLC want to resolve the conflict. You don’t want to have to rely on rules drafted by a group of legislators years ago without your particular business in mind! Make your own rules – ensure you have an operating agreement to protect your business.
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