Food for thought for the would-be entrepreneur (part 7 in a series)

A long, long time ago, a person who started a business was a sole proprietor, and 2 or more people who shook hands to begin a business were partners.  (And nobody was a “member.”)

A partnership happens spontaneously anytime 2 people, together, buy a house to flip – or begin any other money-making venture.  A partnership does not necessarily have “LLC” after its name, but it can.  It can also have “LLP” (limited liability partnership.)  A partnership does not even need a legal filing, though it would probably be a good idea.  That is, the group really can just shake hands and start the business.

The distinction between multi-member LLC and partnership is very small, and as far as I can tell, functionally irrelevant for tax purposes.  Most partnerships now register with their state and get the all-encompassing FEIN.  Most partnerships also formally establish themselves as LLCs.  (or LLPs.)

The real difference is fundamentally the paperwork prepared (and signed!) in advance.  Without any paperwork, that is, without any partnership agreements, a group of 2 or more people who start a venture with a profit motive are depending upon the laws of their state to work out any issues and to determine who has what responsibilities and who gets what money.

Consider this:  Kjeld and Knud shake hands on a house-flipping venture.  If Kjeld wanders away and leaves Knud to finish the job, but there is no paperwork, the state could still determine that Kjeld gets half the proceeds of the eventual sale.

Furthermore, if the money trail is non-existent, or comprised primarily of commingled receipts, Knud might not even be able to reimburse himself for all the supplies and materials he paid for from his own funds.

Bottom line:  visit a lawyer!  If you can’t afford a few hundred dollars to protect yourselves from each other, you aren’t ready to go into business.

Food for thought for the would-be entrepreneur (part 6 in a series)

So it’s not just you, but you and your buddy?  Or you and your 14 cousins?  No problem!  You can also form your business venture as an LLC.

What’s the same?  The filing process is much the same.  The banking requirements are definitely the same.  The need to keep your personal and business bank and credit card activity separate continues to be the same.  You must get a federal ID number.  My recommendation for insurance persists, too.

What’s different?  With multiple members, you are no longer treated as a disregarded entity for tax purposes.  Instead, for income tax purposes, the entity’s activities are reported on Form 1065.  (Most states also have a stand-alone form for multi-member LLC’s that file Form 1065 for federal purposes.)  Form 1065 is the federal form for partnerships.  Most multi-member LLCs are de facto partnerships, and they follow their state’s partnership tax rules.

Another big difference is that you really should visit a lawyer to draw up a partnership agreement between all of you.  You may be BFFs today, but the demands of business have a way of shoving wedges between even the closest of friends.  A partnership agreement will address each person’s responsibilities, the way money goes into the venture, the way money comes out of the venture, and what to do if things go south.  Do not get this from your uncle, the real estate attorney!  Spend the time and money to visit an experienced business attorney who will ask you plenty of hard questions.  Be prepared!

With a multi-member LLC, it is very important that you track money, especially money between the partners/members and the LLC.  This includes the money each person contributes and the money each person takes out, as well as each person’s share of annual profits/losses.

Finally, like the sole member LLC, the people in a multi-member LLC are still called “members.”

As for taxes…we’ll address that in its own article.