Selecting your Business Entity

Distinguishing between the alphabet soup of business entities is difficult in and of itself. Knowing the difference between LLC and Inc. is sometimes fairly complex. However, simply knowing what these letters mean is of little use. You need to know which entity will work best for your business. Below are some of the traits of the most common business entities and how they can benefit and/or hurt your work in the game development area.

• A note on “pass-through”—for tax purposes, pass-through means that you aren’t being taxed twice for profits earned by your business. Pass-through taxation is when your business profits pass through the business and are taxed on your personal income tax. I say this now because it comes up several times in this discussion and it’s an important point when you’re picking your business.

Sole Proprietorship

If you’re just starting out and you’re working out of your apartment, you are probably a sole proprietorship. A sole proprietor is an individual who owns their business. There is no liability shield and for tax purposes your business profits pass-through. As a sole proprietor, you’ll have a DBA (Doing Business As) that can be your name, your game handle, or something you made up. To register with your state/municipality as a sole proprietorship, you can visit your state’s Secretary of State website. Many states put the forms for most of the business types you need on the website as a service to you.

A sole proprietorship is useful when you are simply selling your services as an independent contractor. If you’re a freelance programmer or designer, you work independently and you don’t need anything more complicated than that. If you actually start selling a product you will probably want to convert to another organization type-- being personally liable for products is a bit of a scary-dangerous business in the event of a civil suit.

Why bother organizing as a sole proprietorship? First, it enables you to deduct business expenses in the same manner as corporations, partnerships, and LLCs. You can deduct things like operating expenses, marketing costs, travel expenses, and some of the notable “write offs” like business lunches. You can also deduct some of your start-up costs and some of your computer/equipment expenditures connected to making your business profitable. Second, it makes you look more professional when you have a DBA. Third, it can protect you in other ways, too.

Let’s look at an example. Say Duke is a freelance contractor /DBA/ Duke Nukem, Sole Proprietorship. He’s offered work by a small development firm. There is no written contract in place, just an oral agreement that he will do the work for a certain amount of cash. Duke writes unique programming code for the benefit of the development firm.

Who owns the copyright to the code? If Duke is an independent contractor, he does. If he is an employee, the developer does. Duke really, REALLY wants to be an independent contractor in this scenario because he wants to be able to use and sell the code in the future. Being a sole proprietorship and having a /DBA/ supports Duke’s contention that he is, in fact, an independent contractor. Otherwise the developer would have a stronger argument supporting the contention that Duke was an employee at the time he wrote the program code.

Having a sole proprietorship has its benefits if you’re working on your own. It’s worth registering yours.

General Partnership

You don’t really need to do much to have a general partnership. If there are two or more people doing business together and no contract is in place, it’s assumed to be a general partnership. General partners share in all profits AND losses of the partnership. General partners are also personally liable. Individual partners are taxed through pass-through taxation based on an equal distribution of profits and losses, unless an agreement is in place that splits the liability/profits otherwise.

A good example is when two or three good friends come up with a game. They design it, program it, and come up with a demo. They do this without any understanding of who owns what, assuming that they’ll all benefit equally when they sell the product. That’s a general partnership.

A lot of people advise against general partnerships. I’m not one of those people. I’m of the belief that when people are personally on the hook for both profits and losses, they will probably be more committed to the venture. It honestly depends on the people you’re working with and how well you trust/know them.

If you do go the partnership route, it is important that you get everything in writing to spell out:

1. How profits will be split;
2. How liability is split;
3. Who owns the rights to what (all partners own products of partnership equally on behalf of the partnership unless an agreement states otherwise);
4. When approval rights are required from the other partners (spell this out, as approval isn’t required when one partner enters into a contract on behalf of the partnership);
5. What happens when one person quits;
6. What happens when a person dies (estate planning);
7. What happens upon dissolution of the partnership;
8. How to bring in new partners;
9. And anything else that may come to mind.

Selecting your Business Entity (Con't)