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Are you curious about the differences among a sole proprietorship, a partnership, and a corporation? A sole proprietorship is formed automatically in most states and in most industries when an individual decides to go into business. In many jurisdictions, the sole proprietor needs to acquire or apply for a business license from the state or local city government. Other than clearing that modest hurdle, sole proprietorship requires no special prerequisites.

A partnership is formed automatically when two or more people enter into a joint business or investment activity for the purpose of making a profit. As is the case with a sole proprietorship, partnerships typically need to acquire a business license from the state and perhaps the federal government. Partnership formation doesn’t necessarily require any additional paperwork or legal maneuvering. If you do enter into a partnership, however, most attorneys (probably all attorneys) will tell you that you do so at a certain amount of risk if you don’t have an attorney draw up a partnership agreement that outlines the duties, rights, and responsibilities of the partners. Also be aware that you can form a partnership simply by collaborating in business with someone. The law books are full of stories of people who inadvertently created partnerships merely by collaborating on some project, sharing office space, or working together on some activity.

By comparison, most states allow several other business forms, including corporations, limited liability companies, and limited liability partnerships. These other business forms sometimes require considerably more work to set up, sometimes the assistance of a good attorney or accountant, and sometimes payment of several hundred — possibly several thousand — dollars in legal and licensing fees. The unique feature of most of these other business forms is that the corporation, limited liability company, or limited liability partnership becomes a separate legal entity. In many cases, this separate legal entity protects investors from creditors that have a claim on the assets of the business. By comparison, in a sole proprietorship or a partnership, the sole proprietor and the partners are liable for the debts and obligations of the proprietorship or the partnership.

If you have questions about the correct business form in which to operate, talk with a good local attorney or accountant. They can assist you in choosing the appropriate business form and in considering both the legal and tax aspects of choosing a particular form. As a general rule, more-sophisticated business forms such as corporations, limited liability companies, and limited liability partnerships deliver significant legal and tax benefits to investors and managers. Unfortunately, these more-sophisticated business forms also require considerably more legal and accounting fiddle-faddling.