Types of businesses

0:00- [Instructor] And what we're gonna do in this video is dig a little bit deeper and learn that there's different legal structures for business organizations and they have different implications. Now, the implications usually are in one of three dimensions. One is how complex that business is to set up legally.

0:19The other is who controls the business. And then last but not least, there's an idea of liability. Now, liability, for a lot of students, you might not think about it a lot, but as you become an adult, and especially as you start running a business, it's a very important idea.

0:35It's essentially if a court decides that you did something wrong, a jury decides that you did something wrong and someone sued you for it, what can be accessed? Can just the business be accessed or can other things you own be accessed? So that's what we're gonna talk a little bit about in terms of liability.

0:56So generally speaking, we can say there's three different categories, and there's subcategories of them and we can get as complex as we like. But the most basic structure for a business is known as a sole proprietorship. Proprietorship. And this is probably the most traditional and the most common.

1:20And this is just an individual or maybe a family, they just own a business outright. Now, this is the simplest situation, and the control rests in one group, or I should say even one person. Let's just assume it's one person who owns it. So one person controls the business.

1:44But this is where it gets interesting. Liability. And actually I'm gonna add another category here, liability and taxes. So if I just set up, say, a restaurant as a sole proprietorship, the liability I have is unlimited. So let's say that someone went to that restaurant and I didn't take care of the ceiling, and the ceiling falls down on someone and hurts them and I was negligent, which means I didn't take care and that person got hurt because of my not taking care and they sue me for a million dollars.

2:22Now in this situation, I have unlimited liability. Let's say the restaurant is only worth $200,000, but I have a house that's worth $500,000. In many states, they're going to be able to access my house. Or let's say that I have another business that's worth another $500,000.

2:40They're going to be able to access that. So here I have unlimited personal liability. Unlimited. Now, another benefit though, even though I have this unlimited personal liability, which can be a big deal if I'm running a business, is that I only get taxed once.

2:59Any profits of the business, they just come into my personal taxes. So I'm only going to be taxed once. And you might say, hey, is there any situation where you'll be taxed twice? Well, yes there is, but there are reasons for why you are getting taxed twice. Now, related to a sole proprietorship, you could have a bunch of people owning a business together.

3:21And that would oftentimes be called a traditional partnership. Traditional partnership. And there could be different combinations of it. You could have a general partner who really acts like a sole proprietor. They have control, they have unlimited liability. And then you could have limited partners who don't have control.

3:44They can participate in the profits of the business, but they have more limited liability. So I could say more complex. More complex. It is shared control depending on who are the general partners. It could be many people. You could think of something like a law firm, or sometimes investment firms have many people controlling it together.

4:07They are all partners. You've probably heard on legal shows, oh, I want to make partner. Once you're a partner, you have shared control of the law firm and you get a cut of the profit. You're not just a salaried employee anymore. And then the liability, it depends on whether you are the general partner or whether you are a limited partner.

4:27And depending on how you're structured, and we'll talk about traditional S corps, or I guess I should say just S corps later on. But if you're set up as just a traditional partnership or something else I'll talk about, which is an LLC, which stands for limited liability corporation, then you are only taxed once.

4:47Now, limited liability corporation, whether it's one person owning it or there's a bunch of people owning it, it's oftentimes a really good idea. And that's because it's a little more complex. So more complex, but not super complex. It is something that an individual person can handle generally.

5:08Controls, that depends. It could be a partnership, it could be a sole proprietorship. But the liability is limited. That's why it's called a limited liability corporation. So you get that benefit, and you are only taxed once. So the profits, let's say I'm the only person owning that limited liability corporation, and there's a certain amount of profit, that just comes into my personal taxes and I just pay taxes on it as an individual.

5:35Now, I do really wanna stress what this limited liability means. This means, let's say I have a restaurant right over here. This is me. And let's say that I have this restaurant. I'll say R for a restaurant. And this restaurant is worth $500,000. It has 500,000 of assets and cash and however else you wanna value it, because it generates profit, it's worth something.

6:02But let's say I own other things. Let's say I own a car that is, I don't know, $50,000. That's pricier than the car that I actually own. And let's say, and this isn't me, this is a hypothetical me, I don't own a restaurant. Let's say that I own another business, another business that is worth $1 million.

6:29Now, in the situation where I just described, someone goes to this restaurant and the roof falls on them and they get really hurt and they sue me, and a jury decides, or court decides that, hey, yes, that restaurant is really negligent. They should have fixed that roof.

6:47They knew it was bad, it fell on the person, and that person had to be in the hospital for a week. So their lawsuit for a million dollars is valid. So the restaurant owes that person $1 million to the person whose head got hurt. So they're in bad shape because we didn't repair that restaurant.

7:08We are negligent. Now, in limited liability, as long as that restaurant was truly operated as an independent entity and it had proper insurance, it was properly capitalized, it had enough assets, well, then that person can only sue the restaurant here. So the restaurant would essentially give it the $500,000 or whatever they have, and then the restaurant would probably go out of business or maybe you just have to give the whole restaurant to that person.

7:33There's different ways to think about it. But that person said, "Hey, I only got $500,000. You have all of these other assets. I want some of that." But as long as you ran that LLC as a truly independent entity and it was capitalized right, then they're not going to be able to access it, these other assets.

7:51And so that's why we say limited liability. Now the last, and this is probably the most common for the big corporations you know, there's something known as an S corporation. There's other forms of corporation we could talk about. I don't wanna get too complicated, but this tends to be the most complex.

8:11But all the big companies that you hear of, the Microsofts, the Googles, the Ford Motor Company, these are all S corporations. Now, who controls them? Well, these are the shareholders. Shareholders control it. So when you go buy stock on the stock market, you are buying a share of let's say IBM or you are buying a share of Google.

8:34You have a vote now. It might be one of a billion votes, but you have a vote now. And it doesn't just have to be public corporations. We have other videos that talk about the difference. You could start a new company. I could start a restaurant as an S corp, thinking that maybe one day it needs to take outside investment, it needs to have that complexity that we're talking about.

8:56Now, a benefit of this is we do have limited liability here. So let me write limited there. Now, one downside of it, you are taxed twice. What do I mean? Well, every year the corporation's profits are going to be calculated and then the government will tax them at the corporate tax rate.

9:17And then those profits, whatever's left over, the corporation, they could keep it internally or they could give it to the shareholders. That's what a dividend is. And so if the corporation then gives a dividend to the owners, then they get taxed again as personal income tax.

9:33Now there's ways of getting around that kind of with things like share buybacks. But if you were to just say the corporate made some money, corporation made some money, they get taxed once, and then that money dividends out to the shareholders, then they get taxed twice.

9:46Now when we're talking about corporations, you'll also hear things like franchises and cooperatives. Those are really ways of running these things. A franchise, you could set it up as really any of these. Let's say you could set it up as an LLC, and what happens there is you go to someone who already has a great restaurant concept say, and you say, hey, can I use your name?

10:06Can I use your recipe? Can I use your branding? And they say, sure, you can, but you have to pay us a certain amount of your revenue. You have to order all of your food from us, all of the supplies from us, and we approve whether your restaurant is really meeting the grade.

10:19But if you do all of those things, then we will let you franchise. A corporation is a, sorry, a cooperative, I should say, is a situation where the owners of the company, and you can actually structure it in multiple different ways. The owners of the company are the people who use the company, who are the customers of the company, so to speak.

10:40So some of these cooperatives, your parents or yourself might be a member. You have to pay a membership fee, and at the end of the year, they send you a check based on how much extra profit that cooperative actually made. We can go into more detail in other videos, but this is already a lot of information to digest.

10:56And if you really understand this, you're actually ahead of the curve compared to most folks.