Franchise parent companies generally require franchisees to sign a contract. However, as noted by Chron, a part of the daily Houston Chronicle newspaper, a franchise agreement may not stipulate that franchisees form a specific business structure.
A sole proprietorship
Many individuals begin working under a sole proprietorship, which means that the business is the same as its owner. IRS rules stipulate that sole proprietors must use U.S. Individual Income Tax Return Form 1040 to report the annual income and losses from a franchise unit.
Because a sole proprietorship does not separate you from your business, a failed franchise unit may leave you responsible for its debts and allows creditors to file a legal action against you as an individual. If your franchise did not generate enough income to pay its business obligations, you may need to use or sell your personal assets to pay them. Your agreement with the franchise’s parent company may also outline that it has no liability for your unit’s unpaid loans, taxes or expenses.
A corporation or LLC
Unlike a sole proprietorship, structuring your franchise as a corporation or LLC could shield you from any personal liability from franchise unit debts. Under either entity, in California, assets in a corporation or LLC are taxed and completely separate from the owner’s assets.
Debts incurred are also separate. A franchisee who faces a lawsuit brought by a creditor or a legal claim brought by an employee will also generally not face any personal responsibility, as the lawsuit is filed against the legal entity in most cases.
When considering franchise opportunities, careful planning and research when it comes to selecting the right business structure is vital. There are pros and cons to each. Consulting with a legal professional who has knowledge in franchise laws and entity formation is advised. He or she can explain your options in greater detail and provide advice and what is right for you and your circumstance.