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When starting a business, choosing the type of business to set up is an important and essential first step. Businesses come in many forms, and the type of business you establish will determine the “rules of the road,” in how you do business. While the exact relations within the business can vary greatly depending upon the ownership and size, in Iowa, there are at least five popular business types that can offer its business the right platform in going forward: a partnership, a corporation, a limited liability company, a professional corporation, and a nonprofit corporation. Figuring out which type of business for you can be a very complex matter. You should seek the help of an experienced Iowa Business Attorney. Read on to get a general idea of each type of business under Iowa law.
What is a Partnership?
A partnership is probably the most informal of these business types. A partnership is essential, an agreement or contract between two or more people agreeing to work together for a common business purpose. Sometimes two friends decide they want to go into business together. They can write up a contract or a partnership agreement that outlines the rights and responsibilities of each person.
While both will have the common goal of making profits, each may have specific skills and assets that they want to bring to the partnership. The value that each partner brings into the partnership is called a “contribution.” A contribution can be of three types: equity or money, skills such as accounting, trade knowledge, or specialized experience, and equipment such as computers or heavy equipment.
Each partner owes a duty of loyalty and sharing information with the other. A partnership can be tailored to fit the particular wishes of the partners or owners who share profits and losses according to their partnership agreement or according to their contribution.
One unique thing about a partnership: there are no business taxes to be paid by the partnership because all income is taxed only as personal income. One drawback, however, is the partnership does not have limited liability, and each of the partners can be fully liable for the debts experienced by the partnership. Partners thus need to know and trust each other well in order to be effective as a business.
What is a Corporation?
A corporation is another prevalent form of business. This was formed by drafting its constitution, which had two governing documents: the articles of incorporation, which lays out the basis of ownership shares and parties, and the bylaws, which govern the shareholder’s rights and responsibilities. A corporation, like a partnership, is owned by its shareholders, who hold company stock or shares. The articles of incorporation can provide for different types of shares, either common stocks, which allow for profits to be paid to each shareholder according to the number of their shares, or the share can be preferred stock, which also allows for dividends payments.
The decision to pay profits and dividends is made by the board or directors. These company officers are “higher management,” who hold board meetings and decide the more important decisions of the company. The day-to-day management of the company is done by the non-board of directors or management, who are responsible for the operational management of the company. One crucial difference between a corporation and a partnership is that the corporation has limited liability, meaning that the owners are limited to the extent of their investment and cannot be sued personally for company losses. This is an advantage over a partnership.
What is a Limited Liability Company?
Another type of business is a limited liability company, or LLC. This can be seen as a hybrid business as it is composed of some of the advantages enjoyed by a partnership and a corporation. Like a partnership, an LLC is created as an agreement between two or more partners who are in an LLC called “members,” or owners. The members govern or make decisions about the company according to their membership agreement.
The membership agreement will contain details about the contribution of each member and the profits distributed to each member. Like a corporation, members can be owners and make company decisions; this type of member is an active member because they participate in the everyday management of the company.
Other members who do not want to be directly involved in the daily management of the company but who want to invest in the company for a return on the profits are called “passive members.” And like a corporation, members have limited liability, meaning they are not personally liable for the debts and wrongs of the company. Their losses are limited to their investment in the company. Unlike a partnership which needs to be careful about outside investments coming into the partnership because it will bring the unlimited liability of another partner, both corporations and LLCs usually encourage outside investment in order to raise needed capital. For more information on how to form an LLC, read our article, How Do I Form a Professional Limited Liability Company in Illinois or Iowa?
What is a Nonprofit Corporation?
Another type of business is a nonprofit corporation or company. Nonprofits are in some ways different from a for-profit corporation in that nonprofits are organized not around a business purpose but with a charitable cause or mission.
This type of corporation helps fill the need for businesses to be involved in causes that are not primarily intended to be money makers or a cause that cannot be undertaken as well by a for-profit corporation. Museums, private schools, universities, and hospitals are nonprofit companies that adopt a charitable cause such as the preservation of cultural artifacts, education, and providing health care services and other causes which might not be done well by a corporation as a profit-making activity.
Like a corporation, a nonprofit is governed by a board of directors who are responsible for keeping the nonprofit on track with its charitable mission and making sure that the company avoids conflicts of interest. And like a corporation, a nonprofit has limited liability. Still, it does not have shareholders because the nonprofit belongs to its members, individuals who either subscribe for services or pay fees. Nonprofit monies are held by its directors in a form similar to a trust.
Another essential difference between a nonprofit and a corporation is that it is tax exempt, meaning it does not pay taxes on the money it receives either from the monies it received for its services or charitable donations. In order for a nonprofit to receive this tax-exempt status, however, it must file soon after it is incorporated a filing with the Internal Revenue Service an application for charitable status.
Once approved, the nonprofit can accept donations from the public, who receive a tax deduction based on the value of their donation. The tax-exempt filing, however, is relatively complicated and requires time, and needs to be done by a qualified attorney. Misfiling takes time, and it is vital to its charitable donation status that this tax-exempt status be done as early as possible. If you are unsure of the right type of corporation for you check out our article, How To Choose a Corporation Type In Iowa.
What is a Closely Held Corporation?
The last type of business that is popular in Iowa is the closely held corporation. This is probably the most common form of business in Iowa as it is well suited to family ownership in ways that a corporation and LLC are not. Like a corporation, a closely held corporation has shareholders and a board of directors. It is also formed by articles of incorporation and bylaws.
And like a corporation, it has shareholders, operates for profits, and has limited liability. There is a critical difference from a regular corporation. It is closed to outside investors and generally does not allow members of the public to own shares.
Why? Closely held corporations are formed in order to preserve control of the corporation to a few select owners. It is more like a club that is selective about who owns the corporation. It thus has ownership rules restricting who can own shares and how shares can be sold or traded by their owners.
The restriction on share ownership is often referred to as the right of first refusal. This is a restriction placed upon the sale of stock which requires a seller first to offer the share to an existing shareholder so as to allow the existing shareholders to right to maintain continuous control of the company. Iowa farms business will appreciate this as these are often family-run businesses that wish to keep control of the farm within the existing family, friends, or nearby neighbor shareholders.
If there are no offers to buy the shares from within, these shares can then be sold to interested buyers outside the corporation. This also allows shares to be transferred from generation to generation from within the existing corporation without outsider control. This may present a couple of difficulties, though: needed capital cannot generally be generated from within the company, and also, shares that cannot find an inside buyer may need to be sold to an outsider at a considerable discount or loss. Remember: an outside investor may be as reluctant to invest within a closed corporation in which they are an insider as the inside owners may not welcome an outsider whom they might view as a stranger.
You should speak to an experienced Iowa business law attorney who can evaluate your situation and start the of picking a business type. While this article offers a streamlined explanation of Iowa business, the different types can be confusing to some, and you should seek the assistance of an attorney if you still have questions. If you are looking for help with your business matter, feel free to call O'Flaherty Law; we would be happy to help you.