I am becoming a wholesale car dealer in CA, and am setting up as a sole proprietorship. My uncle is going to help me finance the business (mainly help buy the cars) on an on-going basis. Is this allowed? Will I still be able to set it up as a sole proprietorship, or does it have to be a partnership. He will actually not be involved in any way with the business activities, but will just be an investor providing capital. Also, on his end, will the profits he realizes be investment income? I guess Iím just trying to figure out how all of this will work. Thanks
4 Answers from Attorneys
Really bad idea to be sole proprietor rather than have a corporation for the business; your personal assets are at risk in any legal action against the business. Worse would be a 'partnership', whether formal or not, because all partners are 'un-limitedly liable' for the actions of the others and all would get sued. If you are serious about running a real business, and about getting it set up right, feel free to contact me. A corporation can borrow money, take investments, etc.
Whether two or more people collaborating on a business deal become partners or not will depend upon whether their activities meet the statutory definition of a partnership, which is:
"....... the association of two or more persons to carry on as coowners a business for profit forms a partnership, whether or not the persons intend to form a partnership." (There is more to the definition, not applicable here).
If your uncle is just lending you money, even if it is secured by your inventory, he is not a coowner and therefore there is no partnership. If, however, he shares in the profits (or losses) of the business, it will probably be deemed a partnership, since sharing in the profits is one of the hallmarks of ownership.
Business investment breaks down into two kinds: debt financing and equity financing. The difference is that debt financing implies lending and an obligation to repay, while equity financing involves putting money into the business with the expectation of sharing in the profits or growth in value of the business, rather than or in addition to getting repaid on a loan.
One way to eliminate this issue, and some others as well, is to incorporate the business, elect tax treatment as an "S" corporation, and remain the sole stockholder. Have you considered this?
I agree with Mr. Whipple. I have seen judges rule that a business was a partnership, even though one person insisted it was not, because of the sharing of profits and losses. You should define your business relationship with your uncle in writing, before hand, to help you determine whether you are going to be a sole proprietorship or need to incorporate.
You can choose from among several forms of entities for your business (corporation, LLC, partnership), depending upon your goals and needs of the business and tax consequences. You can have different arrangements with your uncle regarding his role in your business, but make sure to put your verbal agreement in writing. Do you want him to be your partner? If not, you have to make sure that your agreement with him makes this clear. He can be your joint venturer, your partner, an investor, a lender, a shareholder in your corporation or a member in your LLC, depending on what your expectations are, but it is up to you to define the relationship in clear terms and in writing. It would be wise at this point to invest some funds in obtaining competent legal advice in order to save a lot of money and headache later on.
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