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Legal Reference
A Comparison of Business Entities

The selection of the most advantageous form of organization for any particular business involves weighing many practical and legal considerations. The most important distinctions among the available forms of business enterprise include the cost and formality of organization, transferability of ownership interests, continuity of existence of the enterprise, vesting of management and control, ability to obtain capital and credit, method of participation in profits, and vulnerability to liability. A final important consideration, which can frequently be controlling, is taxation of the enterprise.

Colorado recognizes most typical forms of business enterprise and has adopted the Uniform Partnership Law, the Uniform Limited Partnership Act, the Colorado Uniform Limited Partnership Act of 1981, the Colorado Limited Liability Company Act, the Revised Model Business Corporation Act, with some local modifications, and the Colorado Cooperative Act. For a small business, the available forms of business enterprise include the individual or sole proprietorship, the general partnership, the limited partnership, the limited liability company, the business corporation, and the cooperative. Each of these forms of business enterprise is adaptable to the small business venture, and it is important to compare them in terms of the various considerations discussed herein.


1. Individual or Sole Proprietorship. The sole proprietorship is a simple and the most common form of business enterprise. The distinguishing characteristic of a sole proprietorship is that it is owned and managed by one person. The individual proprietor owns all business assets and carries on the business for himself. The individual proprietor may hire employees and agents to assist him, but he has ultimate responsibility and authority for all decisions affecting the business. Generally, no legal formalities are necessary to create an enterprise in this form. The sole proprietor is entitled to all of the profits and, broadly speaking, can enter and exit from the business as he pleases.

2. General Partnership. This is a sharing of profits and co-ownership in a business. A partnership is an association of two or more persons to carry on, as co-owners a business, for profit.1 A partnership is created by agreement, either oral or written, and the relations of the partners are largely governed by that agreement and by the Uniform Partnership Act as adopted by Colorado. The partnership agreement may be informal, although a formal contract is preferable. The partners must agree to share in the profits of the business and usually also agree to share in the losses and in the assets upon dissolution. For many purposes, a partnership is not considered a separate legal entity distinct from the partners, although this is not always a disadvantage (e.g., qualification is not necessary to do business in other states). Today, a partnership is recognized for some purposes as a separate entity; it may own real property in its own name2 and may be sued in the names of the individuals doing business as a partnership, in the firm name, or both.

A partner is a "co owner" with his partners of specific partnership property "holding as a tenant in partnership."3 Under the Uniform Partnership Law, all property originally brought into the partnership or subsequently acquired, by purchase or otherwise, on account of the partnership is partnership property and, unless there is a contrary intention, property acquired with partnership funds is partnership property.4 The partners may provide in their agreement that title to partnership property may remain in one partner. Generally, property purchased by a partner in his own name after the organization of the partnership is not partnership property unless so provided by the partnership agreement or unless there is a clear intention that it is to be partnership property.

Apart from the rights, duties, and liabilities of the partners arising from the partnership agreement, a fiduciary relationship also exists between partners as a matter of law, and each is bound to act in the utmost good faith in all dealings and transactions that affect the others in the partnership business. The Uniform Partnership Act provides that the partnership must indemnify every partner with respect to payments made and personal liabilities reasonably incurred by him in the ordinary and proper conduct of the business or for the preservation of the partnership business or property.5

The fact that the relationship is a fiduciary one does not bar a partner from dealing with the firm as an individual. However, a partner cannot engage in a business in competition with that of the partnership without the consent of his partners.

Finally, it is important to note that, as a partner, each member of the firm is personally liable for the debts and other liabilities of the business. This is clearly a disadvantage of this business form.

3. Limited Partnership. A limited partnership is similar to the general partnership in some ways, and similar to a corporation in others. This is a partnership in which, by complying with certain statutory requirements, one or more of the partners has only limited liability and, only limited participation in management. The primary purpose of the limited partnership is to allow one or more individuals to invest in the partnership without incurring the unlimited liability of a general partner. It is a form of enterprise that is fairly common today in certain businesses (e.g., investment and entertainment businesses, farming, and real estate ventures).

The Colorado Limited Partnership Act of 1981 governs the formation and operation of limited partnerships. This Act became effective in Colorado on November 1, 1981. One significant feature of the limited partnership is that it has certain quasi public characteristics, which pose some additional problems and may operate as a trap for the unwary.

Each limited partnership must have at least one general partner who will face all the risks and responsibilities of a partner in a general partnership. The limited partners receive the protection of limited liability unless this favored status is lost by participation in the management of partnership affairs.

4. Limited Liability Company. Colorado became the third state to authorize the creation of a limited liability company. The limited liability company, like Subchapter S corporations and limited partnerships, combines the favorable tax treatment of partnerships with the liability of corporations. Limited liability companies can be more flexible than these more traditional entities, although the case law and statutory interpretation has yet to develop, and the precedent for support of certain action in limited liability companies is negligible.

The limited liability company avoids the restrictive requirements of share ownership in a corporation, and permits the flexibility for special allocations and distributions of cash and other assets to its members in a manner similar to that of a limited partnership.

It is formed like a corporation, by filing Articles of Organization with the Secretary of State, but the internal operations of the limited liability company are generally governed by an Operating Agreement, similar to a partnership agreement in a partnership and by-laws in a corporation.6

The owners of a limited liability company are called members. Members have certain statutory voting rights, including the right to vote for managers of the company7 and the right to approve or disapprove of transfers of interests by other members.8 New members may be admitted only with the unanimous written consent of all existing members.9

Limited liability companies are managed by one or more managers who are elected annually by a vote of the members.10 Managers are analogous to directors and officers in a corporation and partners in a partnership. The managers are limited in their authority to act for the limited liability company only by the Operating Agreement and the manager's fiduciary duties to the company.

The interests of a member in the profits and capital of the limited liability company may be transferred in accordance with the Operating Agreement. However, unless the transfer is approved by all of the members of the limited liability company, the transferee of such an interest has no right to participate in the management of the business or to become a member.

Dissolution of a limited liability company occurs automatically upon the unanimous written consent of its members or at the time or upon occurrence of events specified in writing in an operation agreement.11 The business of a limited liability company may be continued if there are at least two remaining members and if all of the remaining members so agree.

The members of a limited liability company have limited liability, as in a corporation. All income from a limited liability company is taxed to the individual members, as in a partnership, under federal and state tax laws.

5. Business Corporation. A corporation is an artificial person or legal entity created by, or under, the laws of a state or of the United States. It may be owned by one or more shareholders who themselves may be natural or legal persons. It is regarded, in law, as having a personality and existence distinct from that of its several members. It can acquire, hold, and convey property; sue and be sued in its own name; and generally do all things in a legal sense that a natural person may do.

The shareholders' rights are determined by the corporation's charter and the applicable statutes. The "shareholders" of a non profit corporation are called "members. " While the shareholders are the owners of the corporation, they are not agents for it (unless they are also officers or employees). Unless shareholders are officers, directors, or controlling shareholders in certain situations involving a duty of loyalty to the corporation, they do not owe a fiduciary duty to the corporation.

The Colorado Business Corporation Act12 became effective on July 1, 1994. As a creature of statute, a corporation cannot do business in states other than the one that created it without first qualifying, and it is not entitled to the "privileges and immunities" of a citizen under Article IV, Section 2, of the U.S. Constitution. It is a citizen for purposes of "diversity of citizenship" when seeking to invoke the jurisdiction of the federal courts.

A business corporation is subject to greater governmental regulation, and the statutory formalities respecting the formation and operation of corporations must be strictly observed. For a small business these may be nuisance factors that must be considered in determining the appropriate form of business organization.

6. Cooperative. Cooperatives handle all kinds of commodities and there are many different types of cooperatives doing business. For example, there are cooperatives that sell groceries, cooperatives that sell electricity, and some that provide telephone service. An agricultural cooperative is a business organization, usually incorporated, owned and controlled by member agricultural producers, which operates for the mutual benefit of its members or stockholders, as producers or patrons. Many cooperatives do not limit themselves to doing business with only members or agricultural producers.

In a cooperative the investment and benefits gained are shared equitably by its members in proportion to their use of the cooperative's services. In other words, members share in the profits of a cooperative, usually on a patronage basis of business done with the cooperative. Members are generally not liable for any debt, obligation , or liability of the cooperative.

Unlike a traditional corporation, monies paid or equities allocated on a patronage basis to members are generally not taxed at the corporate level. Members pay income taxes on monies that they receive or equities that are allocated by the cooperative. Qualified allocations of equity to a member is accompanied by a payment of at least 20% in cash, to help the recipient pay income taxes, and many cooperatives pay at least 40% to 50% in cash. The payment of the non-cash portion of profits, in the form of equities allocated to members, is deferred until a later date and is retained by the cooperative and used to capitalize the cooperative. Payment of deferred equity is made pursuant to an equity retirement program and policies by the board of directors of the cooperative.

Cooperative do business with non-members. Profits generated from non-member business are not paid or allocated to members and income from non-member business stays with the cooperative and is taxed at normal corporate rates.

A cooperative is democratically controlled, often one member one vote, by its members. Proxy and cumulative voting is seldom allowed. In the case of an agricultural cooperative, the members are producers of agricultural products. Others that share in the profits of an agricultural cooperative are often referred to as "participating patrons." The primary distinctions is that members have the right to vote on various issues while participating patrons do not. The result is that the control of an agricultural cooperative remains in the hands of agricultural producers by their vote, including the right to cast a vote for the election of board members to a board of directors.

Both members and participating patrons usually pay a fee to either become a member or participating patron. With some cooperative the fee may be as little as tend dollars ($10.00) or hundreds of thousands of dollars.


1. Sole Proprietorship or Partnership. If the organizer of the business decides to operate as a sole proprietorship, or if the organizers decide to operate as a partnership, there are no state or local taxes to be paid for the privilege of thus organizing the business. The sole proprietorship or partnership must comply with the applicable tax and license laws, but there are, at present, no taxes or fees for organizing an unincorporated business other than a $6.00 fee for filing with the Department of Revenue and a $10.00 filing fee and a very nominal publication cost, which is incurred under the "Assumed Name" statutes.

2. Limited Partnership. Persons desiring to form a limited partnership are required to pay a fee of $50.00 when filing the certificate of limited partnership with the Colorado Secretary of State. Additional fees must be paid when filing any amendment thereto.

3. Fees for Formation of a Limited Liability Company. Persons desiring to form a limited liability company in Colorado are required to pay a fee of $50.00 for filing the Articles of Organization with the Secretary of State. Thereafter, a report must be filed annually with an annual fee.

4. Incorporation Fees for Colorado Corporations. Persons desiring to incorporate a Colorado business are required to pay a fee of $50.00 for filing the Articles of Incorporation with the Secretary of State and for the issuance of a certificate of incorporation. Biennially thereafter, a corporate report, including a $25.00 fee if filing in paper or $10.00 fee if filing online, must be filed.

5. Incorporation Fees for Colorado Cooperatives. Persons desiring to incorporate a Colorado cooperative a required to pay a fee of $50.00 for filing the Articles of Incorporation with the Secretary of State and for the issuance of a certificate of incorporation. Thereafter, a copy of the cooperative's most recent periodic report must be filed with an annual fee.

All of the above fees are subject to change on an annual basis in July of each year.


There is less publicity required of sole proprietorships and partnerships than of limited liability companies, corporations and cooperatives, as the latter have to make reports and filings with governmental bodies. On the other hand, there is often an anonymity attached to the names of the owners of a corporation that may not exist for the owners of the other forms unless an assumed name is used.

A limited partnership must file a certificate with the Colorado Secretary of State, and this results in the disclosure of all the partners' names. Sole proprietorships and partnerships conducting business under a name other than that of the principal(s) must also file an affidavit disclosing such name(s) with the county in which business will be carried on.13


1. Individual or Sole Proprietorship. With very few exceptions, the sole proprietorship terminates by law upon the death of the proprietor. The owner of the business may will his business to relatives or to an employee, but there is no assurance of continuity of the business after death. If the owner manages the business and there are no relatives or associates willing to continue it, the business will most likely be liquidated. The estate planning documents for the sole proprietor should grant authority to his personal representatives permitting them to continue the business as necessary until it may be conveniently and profitably liquidated, and to employ persons to assist in liquidation. There are no restrictions on the sole proprietor in the sale of such a business aside from the "bulk sales" requirements of the Uniform Commercial Code.

2. General Partnership. As with the sole proprietorship, the general rule of partnership law is that the death or withdrawal of a partner or the expiration of the term provided in the partnership agreement dissolves the partnership, and the affairs of the partnership are to be wound up unless the partnership agreement provides otherwise.14 However, the contingencies of death or withdrawal can be dealt with in the partnership agreement, although, of course, care must be taken in drafting precise provisions for the continuation of the partnership.

Dissolution of a partnership can result from a variety of causes. As the relationship is created by agreement, a specific date for termination of the business specified in the agreement will control. Similarly, a contingent event, such as the business sustaining operating losses for four consecutive months, will cause dissolution. Moreover, since a partnership is a "voluntary association," any partner who no longer desires to be associated with the firm may withdraw, and thereby cause dissolution.15

If the agreement provides that the partnership would continue for a specified term, the withdrawal may result in liability to the other partners for breach of the agreement, but the partnership is nevertheless dissolved. Dissolution may also be required by operation of law if the partner ceases to be associated with the firm because of death or if he becomes bankrupt.16 Also, dissolutions may be decreed by a court whenever any partner becomes insane or incapable of furthering the partnership business, or conducts himself in a manner so that it is impractical to carry on the business with him; or in any other case, that renders dissolution equitable under the circumstances.17

Dissolution, as a general rule, requires winding up and termination of the business with the subsequent liquidation of the firm's major assets. The Uniform Partnership Act makes two major exceptions to this rule: the business may be continued by the remaining partners if the dissolution was "wrongful," or if their original agreement so provided.

3. Limited Partnership. The role of a general partner in a limited partnership differs from a partner's role in a general partnership in that there is not a technical dissolution of the partnership when a general partner withdraws, retires, dies, or becomes bankrupt, so long as at least one general partner remains in the limited partnership. If there is at least one remaining general partner and the certificate of limited partnership permits the business to carry on with the remaining general partner, the partnership retains its continuity of existence. Also, a limited partnership is not required to be wound up by reason of withdrawal of its general partners if, within ninety (90) days after the withdrawal, all partners agree in writing to continue the business of the limited partnership and to appoint one or more additional general partners if necessary.18 The role of a limited partner in a limited partnership differs from the role of a general partner. The limited partner, as a passive investor, is like a shareholder of the corporation, and his withdrawal for whatever reason should not affect the continuation of the business. Consequently, the limited partners may completely withdraw or be substituted without affecting the continuity of the enterprise.

4. Limited Liability Company. Dissolution of a limited liability company occurs upon the unanimous written consent of its members or at the time or upon occurrence of events specified in writing in an operation agreement.19 A member of a limited liability company may resign at any time by giving written notice to the other members, but if the resignation violates the Operating Agreement, the limited liability company may recover damages from the resigning member for breach of the Operating Agreement, and may offset the damages against amounts otherwise distributable to the member.20

Dissolution may also be caused involuntarily by a decree of the district court through an action filed by the attorney general if the limited liability company has procured its Articles of Organization through fraud, has abused the authority conferred upon it by law, or has failed to properly change or maintain a registered agent.21

5. Business Corporation. The corporation is the most suitable form if continuity of business and transferability of ownership are desired. The Articles of Incorporation of business corporations can provide for perpetual existence, and, consequently, the corporation continues without interruption on the death or withdrawal (i.e., transfer of shares) of shareholders or officers and directors. The corporation itself is not divided among heirs on the death of a shareholder but continues in existence with only the ownership of the shares being affected. This, of course, is a leading attribute of the corporate form and generally makes it easier for a corporation than other forms of business to maintain growth, acquire public identification and goodwill, and attract employees.

However, as a practical matter, this attribute can be almost valueless. A small, close corporation may nevertheless disintegrate on the death of its prime mover, as it is succession of capable management and not perpetuity of the form that is essential to success. Further, the perpetual existence of a corporation can be a disadvantage to a minority shareholder who is "locked in" and not able to bring about dissolution of the corporation. He may not be able to find a market for his shares or may be restricted by agreement in the transfer of his shares.

The transferability of all or some of a shareholder's shares, without the need for approval by the other shareholders, is one of the principal advantages of the corporate form. However, as in a limited liability company, this advantage can be illusory, for there will probably be no ready market for the shares of a closely held corporation. Moreover, such ease of transferability may often be unfavorable to a client who wishes to maintain complete control over his business and does not wish to take the chance of conducting his business with strangers to whom stock may be transferred. This problem can generally be solved with a buy sell agreement.

Dissolution of a corporation may occur for abuse of the corporate form or by agreement of the aggregate membership.22

6. Cooperative. Dissolution of a cooperative may occur voluntarily in the following manner:23 1. The board, by a two-thirds majority vote of the members, shall first adopt a resolution recommending dissolution;24 2. The board shall submit the resolution adopted to the members; 3. Finally the proposal to dissolve shall be approved by a two-thirds majority vote of the members.

However, a cooperative may revoke its dissolution within one hundred twenty days after the effective date of the dissolution in the same manner as the dissolution was authorized.25

Dissolution of a cooperative may also occur involuntarily through administrative or judicial dissolution. For administrative dissolution, the secretary of state may commence a proceeding if the cooperative does not pay any taxes, fees or penalties imposed when they are due, it does not deliver its periodic report to the secretary of state when it is due, it is without a registered agent or registered office in the state, it does not give notice to the secretary of state that its registered agent or registered office has been changed, that its registered agent has resigned or that its registered office has been discontinued, or the cooperative's period of duration stated in its articles has expired.26

Judicial dissolution may occur in one of the following three ways: 1.The attorney general may bring a proceeding before the court if it is established that the cooperative obtained its organization through fraud, or it has exceeded or abused the authority conferred upon it by law; 2. Not less than ten percent (10%) of the members of the cooperative may bring a proceeding before the court if it is established that the directors are deadlocked in the management of the cooperative's affairs, the members are unable to break the deadlock, and irreparable injury to the cooperative is threatened or suffered, or the business and affairs of the cooperative can no longer be conducted to the advantage of the members generally, the directors or those in control of the cooperative have acted, are acting, or will act in a manner that is illegal, oppressive, or fraudulent, or the members are deadlocked in voting power and have failed for a period that includes at least two consecutive annual meeting dates, to elect successors to directors whose terms have expired or would have expired upon the election of their successors; or 3. A creditor may bring a proceeding before the court if it is established that the creditor's claim has been reduced to judgment, the execution on the judgment has been returned unsatisfied, and the cooperative is insolvent or the cooperative is insolvent and the cooperative has admitted in writing that a creditor's claim is due and owing.27


1. Individual or Sole Proprietorship. Since an individual proprietor owns his business directly, his ownership interest may be transferred by a sale of the business assets. In this respect, the sole proprietorship is freely transferable. But as a practical matter, the sale of sole ownership of a complete business is certainly more cumbersome than the sale of shares in a corporation. The sale of a sole proprietorship involves consideration of the bulk sales law, found in Article 6 of the Uniform Commercial Code28 and presently repealed, and the preparation of various closing documents, such as deeds and bills of sale.

2. General Partnership. The ownership interest of a general partner receives unusual treatment under the Uniform Partnership Act. Generally, the Act distinguishes the specific tangible assets of the partnership from the partner's interest, or equity, in them.29 The specific assets themselves, such as buildings, equipment, and furniture, are held in a form of property ownership called "tenancy in partnership," which has some hybrid characteristics between joint tenancy with the right of survivorship and entity ownership by the firm.30 Under tenancy in partnership, partners are said to be co owners, but they may not sell or use the firm property without the consent of the other partners.31 Individual creditors cannot apply their claims against a partner to firm assets, and the partner's heirs have no interest in the specific assets upon death.32 Surviving partners are vested with the deceased partner's ownership interests in the specific assets.33

The partner's interest in the firm is an intangible interest that includes his proportionate equity in the specific assets and his proportionate share of the liabilities.34 This intangible interest, or beneficial right to partnership profit and assets, may be assigned or transferred freely and may be reached by creditors.35 However, while an assignee of a partnership interest becomes a beneficiary of that interest, he does not become a partner unless all the other partners have so agreed.36

The transferability characteristics of the partnership should be considered a disadvantage. A single partner cannot transfer specific assets, nor can he transfer an undivided interest in those assets to an outside person, since the assets are held in tenancy in partnership. While the partner's interest in the firm is theoretically transferable, it is a very unmarketable commodity insofar as the assignee does not become a partner, has no right to management and control, and would simply be entitled to receive whatever profits the interest would accrue and a proportionate share of assets upon dissolution.

3. Limited Partnership. Unless otherwise provided in the partnership agreement, the ownership interests of the limited partners are freely transferable. The limited partnership agreement should specifically provide for free admission,37 substitution,38 and withdrawal of limited partners, and once so provided, a limited partner may substitute other investors for himself, or withdraw from the partnership and receive a return of his contribution. A substitution of limited partners, by agreement or by consent, requires an amendment to the certificate of limited partnership to reflect the change.39 In this respect, while the limited partner's interest may be said to be freely transferable, the procedure to reflect that change in the filed documents is somewhat cumbersome.

4. Limited Liability Company. The interest of a member in the profits and capital of a limited liability company may be transferred in accordance with the provisions in the Operating Agreement.40 However, unless the transfer is approved by all of the members of the limited liability company, the transferee of such an interest has no right to participate in the management of the business and affairs of the limited liability company or to become a member.41 For example, if all of the members do not consent to a proposed transfer, the transferee will not have the right to vote for managers of the company, consent to this admission of a new member, or consent to the transfer of another member's interest in the limited liability company.

The ownership interests in a limited liability company are treated, therefore, very much like ownership interests in a general partnership.

5. Business Corporation. Shareholders' interests in the corporation are evidenced by share certificates, which are usually freely transferable. The only corporate formality that must be observed in the transfer of share certificates is the recording of the transfer on the corporate books. The corporation thus permits the greatest flexibility in the transfer of ownership interest. It may be desirable to restrict the transfer of share ownership under certain circumstances, particularly for a close corporation (one with a small number of shareholders).

6. Cooperative. A cooperative shall impose restrictions on the transfer of voting common stock or membership in the cooperative in its bylaws.42 The bylaws of the cooperative shall prohibit the transfer of the voting common stock or membership in the cooperative to persons not eligible to be a member of the cooperative, and, if the cooperative issues certificates of common stock or of membership, the restrictions must be printed upon every certificate of stock or certificate of membership subject to restrictions.43 The cooperative may also impose restrictions in its article, and may impose restrictions of the transfer of other equity investments in the cooperative in its articles, bylaws or by resolution of its board.44


1. Individual or Sole Proprietorship. The sole proprietorship business is merely an extension of the personal life of the individual proprietor and, consequently, he is individually responsible for all business debts. This unlimited liability may be circumvented to some extent by insurance, but it is impractical to insure against every, conceivable business hazard. It is further possible, although unlikely, to provide by agreement with creditors that any liability on certain contracts will be limited to business assets rather than personal assets. For the most part, individual proprietors are advised to expect full and unlimited personal liability.

2. General Partnership. General partners are individually and fully responsible for their business liabilities and losses. If the assets of the partnership are inadequate to satisfy partnership creditors, the personal assets of the individual partners may be reached to satisfy these obligations. In one sense, the partnership offers an advantage over sole proprietorships since liabilities are apportioned to the partners pro rata, and no one person is required to bear the full responsibility. On the other hand, since each partner has the capacity to bind the partnership, the potential risk of liability is significantly increased over the sole proprietor who is alone responsible for the obligations he incurs. Insurance and partnership agreement clauses may reduce this risk to the partners in some cases. Further, there is a rule called "marshaling of assets," which requires that firm creditors must look first to firm property for satisfaction of their obligations and only if the partnership assets are inadequate may they pursue the individual assets of the partners.45

A partnership is obligated to indemnify a partner who has paid expenses or incurred liability in the ordinary course of partnership business. This specific authority for indemnification should be further amplified in the agreement. The liability of a withdrawing partner or an incoming partner is subject to different rules.46

3. Limited Partnership. Limited partnerships offer limited liability to limited partners. The liability of the limited partner is generally restricted to the amount of his investment as stated in the certificate of limited partnership. The limited liability of the limited partner may be lost if he holds himself out to be a general partner, or participates in the management of the firm.47 A limited partner's name may not be used in the firm name48 and he may not exercise control over partnership affairs.49

4. Limited Liability Company. Members and managers of a limited liability company are not liable under judgments, decrees, orders of court, or in any other manner for a debt, obligation, or liability of the limited liability company.50

A member of a limited liability company is personally liable to the company to perform any enforceable promise to contribute cash or property or to perform services for the limited liability company, unless the obligation to make such contributions is waived by consent of all of the members or unless the Operating Agreement provides otherwise.51 If the members waive the obligation to make additional contributions, the member's obligation may be enforced by a creditor who has extended credit to the limited liability company in reliance on the member's obligation to make the contribution.52 A member is also liable to restore distributions made to that member while the limited liability company's liabilities exceeded its assets, and this liability extends for six years after a prohibited distribution is made.53

Like corporations, limited liability companies may be subject to the doctrine of "piercing the corporate veil" if appropriate formalities of the company are not maintained or the company is used merely as an "alter ego" of its members.

5. Business Corporation. Shareholders' liability is limited in the business corporation. This characteristic is the most attractive feature of the corporation. A properly formed corporation that observes statutory formalities and is properly capitalized will shield the shareholder from any personal responsibility for corporate obligations. The failure to observe these formalities and to maintain adequate capital may result in the personal liability of the shareholder under the doctrine of "piercing the corporate veil."

However, even if a corporation utilizes the proper corporate form, limited liability may not be achieved since a bank or other lender may require the principal shareholder of a small corporation to guarantee the loans and debts of the corporation. Also, lessors may require personal guarantees on leases to small corporations. In such cases, the advantage of the limited liability of a shareholder is of no more than theoretical value.

6. Cooperatives. Membership or stockholder liability is limited in a cooperative. No member shall be liable directly or indirectly, including by way of indemnification, contribution or otherwise, under a judgment, decree, or order of a court, or in any other manner, for a debt, obligation, or liability of or chargeable to the cooperative while it is incorporated.54


1. Individual or Sole Proprietorship. The individual proprietor is vested with full responsibility for the management and control of his enterprise. He may delegate certain management responsibilities to employees as he desires, or voluntarily accept limits required by others, such as creditors, but the management structure of the sole proprietorship always remains very flexible.

2. General Partnership. The general rule of partnership law is that each partner shares equally in management and in business decisions connected with the partnership business.55 However, the partners may agree to a different allocation of voting control or management, and the partnership agreement can delegate the management of the business to one or more managing partners so that the partnership can attain the advantages of centralized management. It is important that the parties clearly understand that, absent a provision in the partnership agreement to the contrary, a majority of the partners can decide on management decisions for the business. Likewise, if it is to be a 50 50 partnership there is a built in standoff, and if they cannot agree they will have to dissolve.

3. Limited Partnership. The general partners in the limited partnership are vested with management responsibility and control. As noted above, the limited partner, in order to preserve his limited liability status, may not participate in management and control of the enterprise. The limited partnership agreement may provide certain things that general partners may not do without the consent of the limited partners,56 but for the most part, limited partners must remain passive investors. Limited partners are entitled to inspect the books and to have an accounting of partnership affairs, and they have the right to be informed on all matters respecting the business of the firm.57 They may also participate in certain management decisions and activities.58

4. Limited Liability Company. Limited liability companies are managed by one or more managers who are elected annually by a vote of the members.59 Managers are similar to directors and officers of a corporation and general partners in a partnership. The managers must be natural persons, 18 years or older, but do not have to be members of the limited liability company.60 Debts of the limited liability company must be incurred by a manager, unless otherwise provided in the Articles of Organization or the Operating Agreement, and all documents affecting real and personal property of the limited liability company must be executed by one or more managers.61 The managers of a limited liability company are subject to less restrictions on transactions with their company than are directors of corporations. A transaction between a limited liability company and a manager is only limited by the limited liability company's Operating Agreement and the manager's fiduciary duties.

Many issues regarding management can be defined in the Operating Agreement. Particularly, the Operating Agreement may contain provisions restricting the manager's authority, stating the manner in which managers may be elected, and describing how their duties shall be performed.

5. Business Corporation. The management and control of a business corporation is vested in the Board of Directors, the shareholders, and the officers. The incorporators control the enterprise during the incorporation stage. The Board of Directors, as elected by the shareholders, is primarily responsible for all management decisions following incorporation.62 The officers, who are appointed by the directors, receive delegated duties from the board, and are responsible for the day-to-day operation of the business.63 The shareholders, who elect the directors, have indirect control through their voting powers and the statutory requirements that they be consulted on major corporate changes. Corporate organizations may be very complex, and the procedures for managing the corporation may be cumbersome. There is, however, a great flexibility in the corporate management structure. Shareholders probably have more control over the business affairs of the corporation than a limited partner has over the partnership, but they obviously have less managerial control than a general partner or sole proprietor.

6. Cooperatives. The affairs of a cooperative shall be managed by a board of not less than three directors as provided in the articles or bylaws elected by and from the members of the cooperative.64 The bylaws of a cooperative shall provide for one or more officers and the titles of those officers.65 Such officers shall be elected by the board or in any other manner prescribed in the bylaws and have the authority to perform such duties in the management of the cooperative as may be provided in the bylaws, or as may be determined by resolution of the board of directors not inconsistent with federal, state and local law, the articles and the bylaws.66


1. Individual or Sole Proprietorship. The individual proprietor is limited to his own personal resources and his ability to obtain loans to capitalize his enterprise. Moreover, he may have to pledge his personal assets as collateral to secure any business loans, and the size of the business is thus, as a practical matter, restricted to the individual proprietor's own resources.

2. General Partnership. Partners' contributions of cash or property to the partnership constitute the initial capital invested. Property so contributed becomes partnership property and is subject to the rules of tenancy in partnership, as discussed above.

The partnership, like the sole proprietorship, is limited in obtaining funds from outside sources. In order to borrow money to capitalize the enterprise, partners may have to pledge their own personal assets as collateral. However, it is important to remember that even without such a pledge, the firm's creditors may reach individual assets, subject to the rule of marshaling of assets.

3. Limited Partnership. Limited partnerships have capital resources from the contributions of limited partners, very similar to the capital resources of a corporation gained from its shareholders. The limited partner risks only his contribution, or his investment. The partner's contribution to a limited partnership may be made in cash, property, services rendered, or a promissory note or other obligation to contribute cash or property or to perform services.67

4. Limited Liability Company. The members of a limited liability company may contribute cash, property, services rendered, or a promissory note or other binding obligation to contribute cash or property or to perform services.68 In this regard, the limited liability company's contributions are as flexible as those permitted for a limited partnership.

A member is personally liable to the limited liability company to perform any enforceable promise to contribute cash or property or to perform services for the limited liability company, unless the obligation to make such contributions is waived by consent of all of the members or unless the Operating Agreement provides otherwise.69 Even if the members waive the obligation to make additional contributions, the member's obligation may be enforceable by a creditor who has extended credit to the limited liability company in reliance on the member's obligation to make the contribution.70

5. Business Corporation. The corporation's ability to attract capital and credit is another strong advantage of this form of business. The corporate financial structure lends itself to a wide variety of debt securities, or loans, and equity securities, or investments by shareholders in the stock of the corporation. The sale of stock is a relatively easy way to obtain investment in a corporation. The size of the investment may be very small or very large depending on the particular needs of the business.

State and federal securities regulations should never be overlooked when considering the capital and credit requirements of a business corporation (or any other business enterprise, for that matter). The issuance of securities to the public may require registration with the state agency and the Securities and Exchange Commission.

6. Cooperatives. Members of a cooperative are primarily interested in the benefits they derive as patrons of the organization. Since benefits in a cooperative are distributed to patrons on the basis of their use of its services, such benefits do not enhance the value of shares of stock or provide a return on invested capital.

Hence, members of a cooperative must provide most of its capital either by direct subscription or by investment of their patronage allocations. The incentives which cause persons to invest in corporate stocks are not present in the case of cooperative stock. For this reason the capital of a cooperative can, for the most part, come only from its member-patrons.


1. Individual or Sole Proprietorship. The federal and state laws regarding the taxation of a sole proprietorship may constitute an advantage in some cases. All business income or loss is treated as the individual's income or loss and taxed accordingly. The sole proprietor declares this income on a separate schedule (Schedule C) of his individual tax return and his individual income tax rates are applied. After the Tax Reform Act of 1986, individual tax rates are generally lower than corporate rates. If early business losses are expected, the loss will operate as a shelter for other personal income of the sole proprietor and will thereby result in direct tax savings. Individual proprietors may qualify for certain retirement plan type deductions.

2. General Partnership. The partnership itself pays no federal income tax. However, each partner is required to declare his share of partnership income or loss on his individual tax return. The partnership is thus treated very much like the sole proprietorship for tax purposes, with the exception that the income or loss will be among the partners in their respective proportions rather than being applied to one person. Profits earned during the year are applied to the individual incomes of the partners whether they have been distributed or not. Losses from the business, as they are attributed personally to the partners, may be offset against other personal income, subject to limitations for passive activities and other rules.

The sale of a partner's interest in the partnership results in a capital gain or loss in much the same way that the shareholder's sale of corporate stock does.

3. Limited Partnership. For the most part, limited partnerships will be treated like a general partnership for tax purposes. This is one reason limited partnerships are favored forms of enterprise to conduct real estate development and operation of rental property. The deductions available to these enterprises can be passed directly to the partners and, subject to various limitations, "shelter" other income from tax.

It is possible that a limited partnership will be considered to be a corporation for tax purposes whenever the operation of the limited partnership closely resembles the operation of a corporation. If the certificate of limited partnership provides for substituted limited partners; continuity of business despite the death, incapacity, or withdrawal of a general partner; and centralized management in a few general partners, the limited partnership may be recharacterized by the Internal Revenue Service (IRS) and taxed as a corporation.

4. Limited Liability Company. The IRS has issued Revenue Ruling 88 76, in which it ruled favorably on the classification of a Wyoming limited liability company to be taxed as a partnership for federal income tax purposes. Unlike a partnership none of the members of a limited liability company are personally liable for debts.71 A limited liability company may be classified for Federal income tax purposes as a sole proprietorship, partnership or corporation. If the limited liability company only has one owner, it will automatically be considered to be a sole proprietorship, unless an election is made to be treated as a corporation. If a limited liability company has tow or more owners, it will automatically be considered to be a partnership, unless an election is made to be treated as a corporation. If a limited liability company does not elect its classification, a default classification of partnership (multi-member limited liability company) or sole proprietorship (single member limited liability company) will apply.72

5. Business Corporation. As a separate entity, a corporation is subject to separate tax procedures and rates by the federal and state authorities. Unlike the sole proprietorship and partnership, where income is merely funneled to the individuals who comprise the enterprise, a corporation is separately taxed on its own income. This causes some advantages and some disadvantages, all of which must be carefully considered.

Corporate taxation may result in "double taxation." Income received by the corporation is taxed at the corporate level according to the corporate rates then in effect. The profit remaining after taxes is then available to be distributed as dividends, which are taxed again as personal income to the shareholder. This double taxation is recognized as a distinct disadvantage of the corporate form, as compared with other forms of business enterprise. Larger corporations with many shareholders simply accept the disadvantage, but in smaller, closely held corporations, double taxation must be minimized. There are several possibilities.

a. Salaries. Whenever shareholders are officers or employees of the corporation, and this is frequently the case in smaller organizations, they may be paid salaries that are deductible as a corporate expense, and thereby be compensated in a manner other than dividend distributions.

b. Loans. The small corporation may be structured so that a significant portion of its capital comes from loans to the business rather than shareholder investment. Having established sufficient equity capital, the remaining funds needed for the business may be raised through interest bearing loans; the interest is deductible to the corporation as an expense. The interest paid to the creditor is individual income to him, but it substitutes for dividends and is not subject to double taxation.

c. Subchapter S Election. The small business corporation may elect not to be taxed at the corporate level, but to have its income (whether distributed or not) passed through and taxed pro rata to its shareholders as ordinary income. This election generally causes the corporation to be taxed as a sole proprietorship or a partnership. It also takes advantage of potential losses in the early stages of the business. The following requirements must be met for a corporation to qualify under the Subchapter S election:

(1) There may be no more than seventy five (75) shareholders.

(2) Shareholders must be natural persons, and cannot be another corporation or partnership, although estates and certain trusts may own shares.

(3) The corporation may only have one class of stock, and may not be a member of an affiliated group.

(4) The corporation cannot have a non resident alien as a shareholder.

(5) The corporation's foreign income and passive investment income may not exceed certain limitations.

All shareholders must consent to the election by signing a separate statement of consent, which is submitted with the application electing taxation under Subchapter S.

d. Employee Benefit Plans. The corporate structure permits the corporation to offer certain benefit plans to its employees. Qualified stock option plans; qualified pension and profit sharing plans; and life, health, and accident insurance plans are all available as corporate benefits.

Qualified profit sharing plans permit a corporate deduction for profits accumulated for employees under the plan, and the employee is not taxed until he receives payment. Qualified pension plans are similarly treated for tax purposes.

Insurance plans may provide a direct economic benefit to employees, who may also be shareholders. The corporation may deduct the expense of paying insurance premiums as an ordinary business expense. Hospital, accident, health, and disability insurance plans may be maintained by the corporation with very few limitations. Group life insurance, with a maximum limitation of $50,000 per employee, may be maintained by the corporation, with the premiums treated as an expense to the corporation but not taxable to the employee.

e. Conversion of Ordinary Income to Capital Gains. There are also certain tax disadvantages and pitfalls in utilizing a corporate form:

(1) If the character of the income of a partnership or a sole proprietorship is tax exempt, such income retains its tax exempt status in the returns of the partners or the individual proprietor. However, if the corporation form is used, such income does not preserve its tax exempt status when paid out in the form of salaries or dividends to the shareholders, although that income is exempted from the corporation's taxable income. Similarly, a dividend traceable to the capital gains income of a corporation is, nevertheless, ordinary income to the shareholders (except in the case of a Subchapter S corporation).

(2) The liquidation of a corporation is normally a taxable event, unlike a similar situation in a partnership or a proprietorship. Moreover, sale of stock or liquidation at a loss may only give the shareholder a capital loss, whereas there is an ordinary loss upon the abandonment of a sole proprietorship or a partnership. The same is true if stock becomes worthless before it is sold. This disadvantage can be avoided in the small business by utilizing Section 1244 of the Internal Revenue Code.

(3) The Internal Revenue Code places a penalty tax on a corporation's earnings accumulated beyond the reasonable needs of the corporation. This tax, called the accumulated earnings tax, is on earnings accumulated for the purpose of avoiding income taxes on the shareholders. The tax is aimed at forcing corporations to pay out taxable dividends. However, for the small corporation it may well not be a problem, as a surplus of $150,000 or $250,000 can be accumulated without incurring this tax.73

(4) Salaries are only deductible by the corporation if they are reasonable in amount.74 Consequently, the excessive portion of a salary paid to a shareholder employee will be disallowed as a deduction by the corporation, while the shareholder-employee will be taxed on the full amount received as either salary or dividend income.

(5) The personal holding company income tax on corporations may be imposed. Generally speaking, when a large portion of the income of a corporation is to be derived from personal holding company sources (i.e., passive or non operating sources), the corporation (unless exempted) may be subject to a 50 percent tax on the undistributed income of a personal holding company. Such corporations are not subject to the accumulated earnings tax. Personal holding company income is defined in the Internal Revenue Code to include dividends; interest; annuities; amounts received from personal service contracts; rents; and mineral, gas, and oil royalties.75 Speaking broadly, a corporation will be classified as a personal holding company if more than 50 percent in value of its outstanding stock is owned by not more than five individuals and if at least 60 percent of adjusted ordinary gross income is personal holding company income. The provisions of the Internal Revenue Code and regulations must be carefully examined if the income of the business is likely to be of this passive nature. If upon analysis it is concluded that the tax may be applicable if the corporate form is used, a sole proprietorship or a partnership may be considered more favorable.

6. Cooperatives. Cooperative's income and expenses for income tax purposes are computed in the same manner as those of other business corporations. However, because they are cooperatives operating under strict rules prescribed by law, they may deduct from gross income certain patronage allocations.

The requirements surrounding these allocations by cooperatives and their distribution to patrons are set out in subchapter T of the Internal Revenue Code.76 By and large what a cooperative can do with patronage allocations taxwise depends upon how the patrons have consented to be taxed.

Patronage allocations can be used to reduce a cooperatives taxable income because they are not to be taken into account in determining the taxable income of a cooperative if paid in money, qualified written notices of allocation or other property. The amounts thus not taken into account by the cooperative and therefore not taxable to it, must be included in the income of the patron for tax purposes, if the amounts arise from the business activity of the patron.

If these conditions are not met, the patronage allocations are "nonqualified" and must be include in the cooperative's taxable income for the year issued. The patron need not include nonqualified allocations in income until redeemed, sold or otherwise disposed of.

Operating on a cooperative basis is essential to tax treatment under subchapter T. Not all arrangements or operating practices satisfy the requirement, for example non-member dividends. In such instances the cooperative is taxed in the same manner as a C corporation since the distributions are not allocated out.


Individuals proposing a new venture will have one or more specific requirements that will determine the business form to be utilized and may choose from a variety of business forms.

1 See C.R.S. 7-60-106, (2002). backBack
2 C.R.S. 7-60-108, (2002). backBack
3 C.R.S. 7-60-125, (2002). backBack
4 C.R.S. 7-60-108, (2002). backBack
5 C.R.S. 7-60-118, (2002). backBack
6 C.R.S. 7-80-203, (2002). backBack
7 C.R.S. 7-80-402, (2002). backBack
8 C.R.S. 7-80-702, (2002). backBack
9 C.R.S. 7-80-701, (2002). backBack
10 C.R.S. 7-80-402, (2002). backBack
11 C.R.S. 7-80-801, (2002). backBack
12 Title 7, Articles 101-117 of the Colorado Revised Statutes. backBack
13 C.R.S. 7-71-101, (2002). backBack
14 C.R.S. 7-60-130, (2002). backBack
15 C.R.S. 7-60-131, (2002). backBack
16 C.R.S. 7-60-131, (2002). backBack
17 C.R.S. 7-60-132, (2002). backBack
18 C.R.S. 7-62-801(1)(c), (2002). backBack
19 C.R.S. 7-80-801, (2002). backBack
20 C.R.S. 7-80-602, (2002). backBack
21 C.R.S. 7-80-808, (2002). backBack
22 See C.R.S. 7-114-101 et seq., (2002). backBack
23 See C.R.S. 7-55-114, (2002) and C.R.S. 7-56-702, (2002). backBack
24 The resolution shall state the reasons why the termination of affairs of the cooperative is deemed advisable, the time by which it should be accomplished, whether or not the board may revoke dissolution and the names of three persons and two alternates to act as trustees in liquidation who shall have all the powers of the board to do all things they deem necessary for the efficient distribution of claims to creditors, in liquidation and termination of the affairs of the cooperative. See C.R.S. 7-56-702, (2002). backBack
25 C.R.S. 7-56-704, (2002). backBack
26 See C.R.S. 7-56-711, (2002). backBack
27 C.R.S. 7-56-714, (2002). backBack
28 See C.R.S. 4-6-101 et seq., (2002). backBack
29 C.R.S. 7-60-125, (2002). backBack
30 C.R.S. 7-60-125, (2002). backBack
31 C.R.S. 7-60-125, (2002). backBack
32 C.R.S. 7-60-125, (2002). backBack
33 C.R.S. 7-60-125, (2002). backBack
34 C.R.S. 7-60-126, (2002). backBack
35 C.R.S. 7-60-127, (2002). backBack
36 C.R.S. 7-60-127, (2002). backBack
37 C.R.S. 7-62-301, (2002). backBack
38 C.R.S. 7-62-704, (2002). backBack
39 C.R.S. 7-62-202, (2002). backBack
40 C.R.S. 7-80-702, (2002). backBack
41 C.R.S. 7-80-702, (2002). backBack
42 C.R.S. 7-56-302, (2002). backBack
43 C.R.S. 7-56-208, (2002). backBack
44 C.R.S. 7-56-302, (2002). backBack
45 This provision is in effect in Colorado at C.R.S. 7-60-141(1), (2002). backBack
46 These rules may be found in C.R.S. 7-60-117 and 7-60-141, (2002). backBack
47 C.R.S. 7-62-303, (2002). backBack
48 C.R.S. 7-62-303(4), (2002). backBack
49 Except matters permitted in C.R.S. 7-62-303(2), (2002). backBack
50 C.R.S. 7-80-705, (2002). backBack
51 C.R.S. 7-80-502, (2002). backBack
52 C.R.S. 7-80-502, (2002). backBack
53 C.R.S. 7-80-606, (2002). backBack
54 C.R.S. 7-56-301, (2002). backBack
55 See C.R.S. 7-60-118 and 7-60-124, (2002). backBack
56 C.R.S. 7-62-303, (2002). backBack
57 C.R.S. 7-62-305, (2002). backBack
58 However, they may do so safely only to the extent specifically authorized in C.R.S. 7-62-303(2), (2002). backBack
59 C.R.S. 7-80-402, (2002). backBack
60 C.R.S. 7-80-401, (2002). backBack
61 C.R.S. 7-80-407, (2002). backBack
62 See C.R.S. 7-108-103, (2002). backBack
63 See C.R.S. 7-108-301, (2002). backBack
64 C.R.S. 7-56-401, (2002). backBack
65 C.R.S. 7-56-402, (2002). backBack
66 C.R.S. 7-56-402, (2002). backBack
67 C.R.S. 7-62-501, (2002). backBack
68 C.R.S. 7-80-501, (2002). backBack
69 C.R.S. 7-80-502, (2002). backBack
70 C.R.S. 7-80-502, (2002). backBack
71 See Internal Revenue Service Publication 334. backBack
72 See Internal Revenue Service Publications 541 and 542. backBack
73 I.R.C. section 535(c), (2002). backBack
74 I.R.C. section 162, (2002). backBack
75 I.R.C. section 543, (2002). backBack
76 See I.R.C. part I of subchapter T (sec. 1381 and following). See also I.R.C. section 521, Exemption of Farmers' Cooperatives from Tax. backBack

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