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What is “creation” of a business entity?
Creation of a business entity is the legal or procedural steps that one must undertake to bring the business entity into existence. There is a general dichotomy in the process or steps required to form a business entity.
Default Entity Status
Some business entities may arise by default without any formal procedural undertaking by the founder. That is, the business entity may arise simply by the parties undertaking some business activity with the intention of generating revenue or making a profit.
- Example: To form a general partnership, the only requirement beyond the physical activity of the founders is the subjective intent of the partners with regard to the responsibilities of each party and the allocation of proceeds (or losses) as they arise. Generally, in the event of dispute, a court will be charged with determining whether individuals carrying on commercial activity are a default general partnership. Notably, the sharing of losses is the greatest indicator of co-ownership of a business, as apposed to an employer-employee or contractor relationship.
- Note: In some cases, a court may determine that a business entity exists pursuant to the conduct or actions of the parties. Further, a court may recognize a partnership to avoid an inequitable result if an entity does not exist. This is known as “estoppel”.
Filing for Entity Status
Some business entities require a formal filing process through the state secretary of state’s office. This requires the filing of documents of organization in accordance with the procedural rules adopted by the state of organization. The amount of information and type of document(s) required will vary between states and depend on the type of entity. The general requirements for each business entity type are discussed along with that business entity.
- Example: Eric wants to form an LLC. He goes to the website for the Nebraska Secretary of State’s Office and downloads the necessary forms. He files the information sheet and articles of organization and pays the applicable fee. Seven days later he receives a Nebraska state certificate of organization for his LLC.
Discussion: Most people do not realize the commercial activity by two or more individuals defaults to a business entity status under certain conditions. Can you think of any consequences that this may have for the partners and business activity? Hint: think about the characteristics of a business entity discussed above. These will help give you an idea of the potential consequences of being deemed a legal business entity.
Practice Question: Eric is thinking about forming a business entity for his personal consulting practice. He has been consulting for several months and is bringing in Audrey, also a consultant, as a co-owner of the business activity. He and Audrey begin operating their consulting practice before filing the applicable business organization documents. What should Eric and Audrey known about their current business entity status?
- By carrying on business together and sharing the profits/losses from operations, Eric and Audrey are (by default) a general partnership. This means that all of the default rules for general partnerships apply.