Restaurant Legal Structure: Sole Ownership, Partnerships, and Corporations
Starting a restaurant can be a daunting task. Establishing a menu, finding investors, and picking up all the supplies you need is enough to overwhelm anyone. And it doesn't help that, on the legal side of things, a new restaurateur has to give her business a certain corporate structure to become fully legitimate, a decision that affects a restaurant's tax structure and liability, among other important qualities.
When it comes to a company layout, options are somewhat limited in the United States, which only offers five choices a restaurant can look over: sole proprietorship, partnership, limited liability company (LLC), S corporation, and C corporation. For the vast majority of restaurants, picking an LLC is often the safest and most cost-effective solution.
Additionally, it is absolutely essential that you check in with an accountant and lawyer for consultation when starting your new business. While guides on the Internet (such as this one) can be helpful, they are not intended to be replacements for real-life meetings with seasoned professionals who can learn the ins and outs of your idea. It may cost some cash to get their input, but it's critical to the success of a new company, especially if you're a first-time entrepreneur.
To get an idea about where to start your discussion with your counsel, it's important to have some grasp of your different options.
Limited Liability Companies
Limited liability companies operate under state statute, as opposed to federal statute. Because of this, it's critically important that you check your state's rules and regulations before filing for an LLC, as they may differ if you're reading from a source that's in Texas when you run a restaurant in California. This kind of company can be owned by one or more people (called "members"), and it can be taxed as a corporation, partnership, or as part of the owner's tax return as a "disregarded entity." This gives the LLC excellent tax flexibility at the end of a fiscal year so you can make the right decisions to maximize profits.
An LLC is also protected against a whole host of possible liabilities, meaning if someone has an allergic reaction to your food, your business is responsible for the damages, but you and other members are not personally accountable. That idea alone makes this option the best pick for foodservice since it means that someone who tries to take your business to court can't come after your house as well. It's important to remember that this option isn't just for independent mom-and-pop restaurants, as well. Even you're part of a chain or starting a franchise, you can still open up a new location as its own LLC, just to be safe — and smart.
A sole proprietorship is a business model where there's no legal distinction between the business and its owner. While this has its management benefits, it means the owner is legally and personally accountable for debts, loans, losses, and other burdens that the business may incur. It also directly ties personal liability with business liability, meaning that a restaurant could accidentally serve food to which someone is allergic, and then the customer could pursue legal action against the business and the owner's assets. It's a great option for people who like total control, but the risks are exceptionally high for restaurants. Cooking that oyster incorrectly or even neglecting a small patch of ice on your sidewalk in December could do some serious damage not just to your customers, but also your life savings.
According to the Small Business Administration, a sole proprietorship is relatively inexpensive to form and gives you total control over your business, but the unlimited personal liability is a huge red flag for restaurateurs. This liability not only affects your relationships with customers, but also with employees, meaning you basically have a 100% chance where you'll have to personally account for someone else's actions, intentional or accidental. This makes it all too easy to lose a restaurant — and your house — from one mishap that got out of hand.
A partnership is essentially the same as a sole proprietorship, except there are multiple people or parties who own the business instead of one. Each entity contributes money, property, labor, or skill to the business, and each entity receives income from the business. Partnerships are also responsible to file an annual information return on income, deductions, gains, losses, and other financial information, but the partnership itself doesn't pay income tax. In addition, each partner must openly share his or her contributions with the business each year, which gives you a lot of wiggle room when working with other partial-owners.
Partnerships include a general partnership, which sets up percentages of earnings and distribution; a limited partnership, which puts a limit on both the liability and input of each partner; and a joint venture, which is a temporary agreement that may later be terminated or permanently establish itself as a general or limited partnership. All of these options have different nuances to them that make them unique, so it's important to read about the laws that apply to them carefully, particularly on the state and local levels.
S corporations are companies that choose to pass corporate income, losses, deductions, and credits to their shareholders, which impacts their federal taxes. The shareholders then report the income flow and receive a tax assessment based on their individual income. Generally, a local business will not want to choose this option, as it is meant for a larger business model. This structure is more intended for big companies who grow into the corporate scene — not fresh upstarts in foodservice.
According to federal law, S corporations are required to register in the states in which they are headquartered, and they are considered unique entities that are separate from the people who started it or currently own it. However, liability protection is more limited than other structures, meaning you retain some responsibility for workplace incidents. This also makes an S corporation a poor — and unlikely — choice for a foodservice entrepreneur, as accidents may commonly occur in commercial kitchens.
C corporations are separate tax-paying entities that have assets of $10 million or more, meaning that new restaurants will pretty much never qualify for this structure. It may sound restrictive, but it's for the best in terms of liability and tax laws.
At the end of the day, most restaurateurs will want to choose an LLC for a foodservice business. That way your personal assets are protected in the event of lawsuits and other legal action, and employee accidents won't be the end of the world. Contrast this with partnerships and sole proprietorships, and you can run into some serious issues by accidentally serving a customer the wrong food. It's in your best interest — and your employees' — to register as an LLC to keep your business protected in case something goes awry. That way, even if something happens, you can keep following your dream of building a successful brand.