So, you want to start a business but you aren’t sure what type of business structure you should choose?
Don’t worry, I got you! Choosing the type of business structure you want to form when starting your business is not a decision that should be taken lightly. This is not a situation where you want to take a quick trip to google university, flip a coin and hope for the best. The business structure you choose will have an impact on everything from day-to-day operations, to liability, and even tax implications. Although it’s possible to convert to a different business structure later, this could result in tax consequences and unintended dissolution among other issues. Trust me you don’t want to start your business off in the trenches like this.
The most common forms of business entities are: sole proprietorship, partnership, corporation, and limited liability company.
A sole proprietorship is the easiest of the entities to form because well… you don’t actually have to complete any formalities to “form” one. You’re automatically considered to be a sole proprietorship if you perform business activities but don’t form any other type of business entity. In actuality, a sole proprietorship is not really a business entity at all, it’s pretty much just a person that wants to start a business that does so under a certain name, whether that be their government name or a trade name, but they have filed nothing.
A Sole proprietorship is not ideal, there are virtually no formalities, there can only be one business owner, and the business owner has unlimited liability for business debts and lawsuits. This means you as the business owner can be held personally liable for the debts and obligations of the business.
To keep it real, the only time I would even recommend a sole proprietorship is to someone who wanted to temporarily test the waters for a low-risk business that doesn’t have customers/clients and only before forming a more formal business. Otherwise, 0/10 would not recommend.
A Partnership is the simplest structure for two or more people to go into business together. There are two main types of partnerships: a limited partnership (LP) and a limited liability partnership (LLP). There are few formal requirements to form a partnership.
Partnerships have a flexible management and operational structure. LP’s have one general partner with unlimited liability, and remaining partners have limited liability. The partners with limited liability also typically have limited control over the company. Profits are passed through to personal tax returns, and the general partner (partner without limited liability) must also pay self-employment taxes.
Limited liability partnerships are similar to limited partnerships, but they give limited liability to all owners. The LLP protects each partner from debts against the partnership and partners are not responsible for the actions of the other partners. Partnerships are recommended for business owners who desire minimal formalities and maximum flexibility, and want to structure business as employees climbing up to partner level such as attorneys.
A corporation is a legal entity that is separate from its owners, a corporation can be taxed, make a profit, and can be held legally liable. Many business owners like how a corporation sounds (oh you fancy huh?) but don’t really want or need this type of entity. While corporations offer the strongest protection to its owners from personal liability, the cost to form a corporation is higher than other entity structures. A corporation is the tuxedo of entity wear, requiring a formal board of directors, shareholder meetings, meeting minutes, bylaws, record keeping, and annual state registration.
When it comes to management, a corporation is managed by the board of directors who are usually elected by shareholders. Directors may appoint officers who run day-to-day operations, and corporations are taxed at the entity level. If dividends are distributed to shareholders, dividend income is also taxed at the individual level. As you can see corporations are in a league of their own.
Corporations are recommended for owners requiring maximum tax and ownership flexibility, combined with liability protection and owners who don’t mind adhering to the corporate formalities and record-keeping burdens. Corporations also need the ability to sell shares to raise capital. So, in short, corporations require time and dime!
The newest addition to the bunch is the limited liability company which is considered a hybrid entity. An LLC lets you get the best of both worlds with the benefits of both the corporation and partnership business structures. Members are not typically liable for the debts of the LLC, which protects you from personal liability. In most instances your personal assets won’t be at risk if your LLC faces extensive debt or lawsuits. Formal meetings and minutes are not required, however annual registration is. Management is flexible, and is typically outlined in an operating agreement.
By default, there is no tax at the entity level; income and losses are passed-through to the members’ individual tax return. Another benefit of an LLC is that owners may elect to be taxed as a C or S corporation. LLC’s and PLLC’s (professional limited liability companies) are recommended for owners who desire strong liability protection with minimal corporate formalities, and the simplicity of pass-through taxation. So basically, an LLC allows business owners to have their cake and eat it too!
Choosing the right business entity in itself can be overwhelming, and it doesn’t stop there. Once you have narrowed down what type of business entity to form, you have to actually form the entity. Oh, and let’s not forget each structure has filing and maintenance requirements as well.
If you need help deciding what entity to form, or if you are ready to move forward with forming a business entity and want to work with a licensed business attorney, then schedule a consultation so that we can get started building the business of your dreams!