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Forming an entity: Five friends in a home building business

Five friends have gotten together to form a home building business. Two of the friends have sizeable assets, but little construction experience. These two also have some experience in running companies. The other three friends have a small amount of capital to invest. Their major contribution to the group is that all three formerly worked for very successful homebuilders, and one individual headed the local division of a national homebuilder for the past two years.

Even with their combined savings, the group realizes that they will need to either obtain bank financing or outside investors. Bank financing will require that the five friends put up their personal assets as collateral. Outside investors will not demand personal collateral, but will demand control. The five friends believe that the company will be a success. Yet, even without having to give a bank personal collateral, they are concerned that if the business fails, they could lose everything they have accumulated.

What type of business entity should the friends form to build homes? Consider whether more than one company should be formed if you believe that other ancillary businesses should be set up at the same time.

Solution Preview

Before discussing various business forms, it should be noted that personal liability for bank loans will be the same for all business forms if an owner has signed a personal guarantee for a loan. Banks are very smart about that, and owners need to understand that banks will not hesitate to collect from the business entity or the personal guarantors.

Going into business involves risk and owners need to understand the risks. Every new business intends to succeed (or they wouldn't start a new business) but I've read statistics that 85% of new businesses fail. I suspect that statistic relates to sole proprietorships but it is worth noting. Prospective new business owners would be wise to schedule a meeting with a CPA and/or attorney to ...

Solution Summary

The 480 word solution compares and contrasts several types of entities, including partnership, LLC (limited liability company), and corporation. This solution does not compare the tax aspects of each entity type, but tends more toward the legal terms and limitations of each type of entity.