A critical decision: choosing the best legal structure for your franchise
Selecting the best legal structure is a major decision for new franchisees. Legal obligations and tax implications are only part of the challenge because the legal structure of a franchise can impact its operations and eventually, profits. Determining the proper legal entity is a key factor that needs to be designated well before signing a franchise agreement.
The most common legal structure options are S-corporations, C-corporations, sole proprietorships, general partnerships and limited liability companies. S-corps are becoming more popular in recent years among franchisees due to the tax benefits afforded to smaller businesses with fewer stakeholders.
However, there are pros and cons to each and so, information regarding the best legal structure for you is listed below.
The pros & cons of each legal structure
Sole proprietorships and general partnerships
These entities are not the best legal structure for franchisees. According to Oblivious Investor, while they offer benefits for small businesses for their tax structure, they do not offer protection from individual liability. The reason for this is sole proprietorships and general partnerships are not separate from a franchisee’s personal legal identity. Thus, any liabilities and claims brought against the franchise would be strictly the obligation of the franchisee.
Limited Liability Company
While LLCs are used by franchisees for the protection offered against personal liability from claims, their flexibility as independent legal entities and the few statutory requirements governing them, do not offer much for a franchise with equity investors. Delaget found that franchises under LLCs run into challenges when issuing equity to investors because they are not distributed in the same structure as corporations. If a franchisee has multiple investors into a franchise, LLCs become more complex from a tax perspective.
With that said, there are tax advantages because LLCs can be designated as flow-through entities, which means no corporate income tax returns need to be filed – all net income is taxed at the individual level.
C-Corporations
C-corps are more ideal for the franchisor than the franchisee, primarily for their equity distribution for investors. This legal structure is most commonly used for publicly traded companies with several equity investors and executive boards. They are also troublesome for franchisees because C-corps are taxed at both the corporate and individual levels. The goal of any C-corp structure is to position a business for future growth by soliciting additional capital investment from investors. So if a franchisee anticipates rapid growth at some point, C-corps could be an ideal structure to reduce tax costs. But for those just starting, this is not an ideal structure.
S-Corporations
The S-corp has gained in popularity among franchisees because of its tax structure. No federal income tax returns are filed because all profits and losses fall down to shareholders. These shareholders then report this information on their personal tax returns with a Form K-1. This is an ideal legal structure for franchisees because they will have a limited number of shareholders, and those shareholders assume the tax liability whether they receive any income from profits or not.
Bottom line
By now, you have realized that selecting the best legal structure for your franchise is a major decision, which requires consultation from an experienced business law attorney. Strictly speaking, however, the S-corp is an ideal option for smaller franchisees due to its flexibility and ability to generate profits without tax liabilities at the individual franchisee level.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, you can get in touch with one of our attorneys at 201-806-3364.
Section 363 Sales in Bankruptcy: What Businesses, Lenders, and Buyers Need to Know
When a company enters Chapter 11 bankruptcy, many assume the process will culminate in a lengthy reorganization plan. However, distressed businesses are increasingly being sold through a different mechanism — a sale under Section 363 of the United States Bankruptcy Code. A Section 363 sale allows a company, as a debtor-in-possession in bankruptcy, to sell […]
Zoning Laws Explained: What You Need to Know Before Buying Property
Before buying property, it is critical to determine whether local zoning laws may affect your plans. If you plan to redevelop the property, you will want to confirm that local zoning regulations permit development as intended. If acquiring property that is already developed, you must verify that the use is permitted in the underlying zoning […]
Special Needs Trusts in New Jersey: Planning for Your Loved One’s Future
For parents of a child with a disability, estate planning raises concerns that go well beyond deciding who will inherit their assets. Parents may spend years making sure their child has the right care, services, and support. Eventually, they must also confront a difficult question: Who will take over when they can no longer do […]
What Every Real Estate Investor Should Know Before Buying a Rental Property
Before buying a New Jersey rental property, an investor should verify realistic operating numbers, the property’s legal and regulatory status, lead-based paint and flood compliance, the existing leases and tenant protections, and the right ownership structure. A rental property is more than a piece of real estate; it is an operating business subject to legal, […]
Can You Change an Irrevocable Trust in New Jersey?
In New Jersey, an irrevocable trust can sometimes be modified even though its name suggests otherwise, and one of the primary tools for doing so is a process called decanting. Whether decanting is available depends on the specific terms of the trust and the discretion given to the trustee. Key takeaways: New Jersey has no […]
How Intellectual Property Valuation Will Impact Business Transactions
Intellectual property valuation determines the monetary value of a business’s IP assets, and it drives outcomes in licensing deals, joint ventures, mergers and acquisitions, financing, and ownership disputes. The most valuable assets of a business are often the things that cannot be seen or touched: a proprietary process, a copyrighted work, brand recognition, or the […]
No Aspect of the advertisement has been approved by the Supreme Court. Results may vary depending on your particular facts and legal circumstances.
Sign up to get the latest from our attorneys!
Explore What Matters Most to You.
Consider subscribing to our Firm Insights mailing list by clicking the button below so you can keep up to date with the firm`s latest articles covering various legal topics.
Stay informed and inspired with the latest updates, insights, and events from Scarinci Hollenbeck. Our resource library provides valuable content across a range of categories to keep you connected and ahead of the curve.
Let`s get in touch!
Sign up to get the latest from the Scarinci Hollenbeck, LLC attorneys!
