Remember though, you don't need a real puppet theater. When I ran a church nursery, I just tossed an old sheet over a table, and everyone was happy. We bought our puppets at thrift stores or made our own out of cloth, socks, or paper bags. The kids can make up stories as they go, act out stories they've just read, and write real scripts, depending on their ages and moods. Plays are fun, too.
Children act out plays very naturally when they are little.
I'll be the mommy and you be the dog. When they get a little older, you can put on real plays. Write scripts together or find simple stories with few characters. Instead of having them memorize lines, just read or tell the story over and over for a few weeks. When they know it, suggest that it would be fun to act out the story.