Starting a business can be an intimidating and exhausting, yet rewarding venture. Seeing your business grow and evolve is a fantastic feeling, but there are some steps you need to take before getting to that point.
From developing strategies to perfecting your product or service, we know you have a never-ending to-do list. One of the most important tasks you’ll face as an entrepreneur is deciding which structure is best for you and your business. This will impact many parts of your company including your financial, administrative, and legal obligations, so it’s necessary to know and compare your options.
You want to select a structure that aligns with your vision to help you achieve your goals as a business owner.
While there are many business structures to choose from, we’d like to focus on the more common types; sole proprietorship, partnership, limited liability company (LLC), and corporation. Let’s breakdown each entity and how they differ from one another.
A sole proprietorship is the most straightforward and inexpensive business structure. You act as the sole owner and operator. These businesses tend to be easier to establish, as you won’t be required to register with the state, but you may be required to apply for business permits and licenses. Under this structure, as a “pass-through” tax entity, tax filings are simple and are reported on your personal tax return. However, as the sole owner/operator, one disadvantage is that you’re left liable for all financial obligations, legal issues, and may face difficulties when attempting to raise money or apply for business loans.
Next up we have a partnership. This is still a relatively simple structure which involves two or more people who share ownership of the business. Three of the most common partnership types are general, limited, and limited liability.
A general partnership gives all parties equal financial, legal, and management responsibilities. One major disadvantage of this structure is that partners aren’t protected from other partners misconduct or negligence.
A limited partnership is a registered entity and consists of one silent partner whose investment is the extent of their liability. The other partner(s) is responsible for daily operations and may be liable for debts associated with the business.
The last partnership type is a limited liability (LLP), which is also a registered entity. All partners share management responsibilities and ownership; however, they have limited liability for the business debts as well as the actions of their partners. This structure is typical for professions that face a higher risk of lawsuits, including accountants, doctors, and lawyers. Partnerships are also considered pass-through entities.
Limited Liability Company
Starting a business has its risks, and that’s why some individuals opt for a limited liability company (LLC). This structure’s often seen as a combination of a partnership and a corporation. Your personal assets are protected when it comes to business debts. However, if a member partakes in any wrongdoing or negligence, those assets are at risk in a lawsuit. With their flexibility, LLCs can be taxed in the same manner as partnerships and sole proprietorships, or like S-corporations. One disadvantage of an LLC is that it’s not the best option if you intend on seeking funding or becoming a publicly traded company in the future.
Corporations involve more complexity in how they’re formed and their tax requirements. They also require more time and carry a much higher cost to develop. Much like LLC’s, corporations have the same liability protections. They are a legal entity, and ownership’s controlled through the shares they have in the company, and they follow the same liability protections as LLCs. An advantage of this structure is that they have the ability to sell stock in the business to raise capital.
Two common types of corporations are c-corps and s-corps. When you incorporate your business, you are automatically considered a C-corp. Taxes are filed through the company as opposed to the individual. They also pay income tax and in some cases are taxed twice– when the company turns a profit and dividends are paid to stockholders on their tax returns.
An S-corp allows you to avoid paying taxes twice by using pass-through taxation. Smaller groups and family companies typically fall under this category. There are specific qualifications that a company must meet to fit this subtype. Unlike C-corps, S-corps are limited to 100 stockholders.
Choosing a Structure
Remember that when you’re forming your business, there are many factors to consider, from your industry, location, tax filings, how much responsibility you’re ready to take on, what risks you’re willing to take, and the longterm goals of your business. Weigh all the pros and cons. Use the information that we’ve provided and make careful consideration and consult with a lawyer or accountant to help you in making the next step towards entrepreneurship. Whichever structure you decide on, know that should things change in the future, you can take the necessary steps to change your company’s structure to suit your needs.