Investing Directly in a Business Part 1
There are a lot of ways to invest money in a company. Generally speaking, though, you can divide investment vehicles into two different categories: direct and indirect investments. With a direct investment, you actually acquire an ownership interest in the company, for example, as a stockholder or a partner.
If you are making a direct investment in a business, whether it is a public company or a mom-and-pop grocery store, it is extremely important to understand the nature of your investment. The terms and conditions of any paperwork that you sign (or don't sign) most likely will determine whether you ever get some or all of your money back on your investment. For example, if the company is sold or liquidates, who gets their money back first?
The primary legal vehicles through which you can make direct investment in a business are:
The Corporation
A corporation is the tried-and-true business entity through which investments are made, as a corporation could serve as a shield to help insulate investors from personal liability exposure. There may also be tax benefits to incorporating, even if the business fails. A corporation is a legal entity that the law treats as a "person" in the sense that the corporation has its own name and identity separate from the owners. A corporation:
- Pays taxes
- Has the ability to enter into contracts
- Can own property
- Can sue and be sued
- Can sometimes be charged with and convicted of crimes
As a separate legal entity, a corporation serves as a shield between the owners and third parties doing business with the organization. So long as corporate formalities are observed, the corporate shield makes it difficult for third parties to go after the owners personally. In other words, if the corporation is sued, the only thing that's usually at risk is the assets of the corporation. A lawsuit could not reach into the pockets of the individual owners. Instead, creditors and other third parties can be limited to going after assets of the corporation.
The Sole Proprietorship
Although maybe not the best alternative in the long run, the simplest and cheapest way to start up a business is as a sole proprietorship. A sole proprietorship means that someone is doing business in an individual capacity and not through any type of business entity.
You can invest in a sole proprietorship by loaning money to the business. But if your investment is something more than a loan, the business may be deemed to be taking on another owner and would no longer be a sole proprietorship. Instead, there is a good chance that it would be labeled a partnership between you and the original owner.
Investing Directly in a Business Part 1
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