Let’s say you have a business idea in mind and a general idea of how you want to execute on it. One of the first decisions you will be asked to make when you go to set it up is how you want the business to be structured. It is important to have the right information in order to make that decision.
Business structure may not be the most fascinating topic to you. How about this for an interesting topic, then?
Want to avoid overpaying income taxes? Or…want to avoid losing your house in a lawsuit?
Do I have your attention now?
A “business structure” is the legal category you choose to fit your business into. The most common structures are sole proprietorships, partnerships, limited liability companies (LLCs), and corporations.
What do I need to consider when deciding which business structure is best for me?
The specific structure that is best for you is going to depend upon your preferences, goals, and risk allocation.
Different business structures will expose you and your personal assets to different levels of risk. Some business structures will completely insulate your personal wealth from the business. Others will leave you personally liable for your business’s debts and financial obligations.
Different structures expose you to different tax obligations as well. However, it is not as easy as picking the structure with the lowest tax obligation, because the profitability of your business and unique situation may mean that your business would pay the least taxes as a corporation, while a business very similar to yours would better function as an LLC.
Also, goals come into play. Are you looking to expand or become publicly traded? If so, you are better off with a C-Corporation.
There are also varying degrees of complexity in terms of legal obligations in conducting day-to-day administrative duties. This means that some business structures will cost more to run and require more effort than others.
In a similar vein, some structures will afford the business owners more flexibility to change their business’s strategy and direction than others. You need to determine how much flexibility you want, and how much control over your business you are comfortable surrendering.
The final consideration is what you want for your business’s future. The structure you decide to form may be permanent or may have a date by which the business needs to be dissolved. Some structures will allow you to grow your business easily and quickly, other structures may hamper expansion. Where you want your business to go in the future needs to be carefully considered when picking the structure that is best for you.
What are the options?
Sole proprietorships. Sole proprietorships are businesses owned and operated by only one person. Sole proprietorships offer complete control over the entire business and are the simplest by far to set up and operate. Sole proprietors do not have to file separate tax returns for the business. They simply report their business expenses and profit on their personal tax returns. They also have little external regulation from the state or federal government. The main downsides of sole proprietorships are that they offer no liability protection to the owner, and they may have difficulty raising capital. Sole proprietors are completely liable for the business’s liabilities, debts, and losses. If the business goes into debt or bankruptcy, the proprietor’s personal assets may be seized to repay the losses. Banks and lending organizations may also be unwilling to lend money to sole proprietorships, and sole proprietorships are not allowed to sell stock, so raising capital is difficult for these organizations.
Partnerships. An alternative to sole proprietorships is a partnership. Partnerships function in much the same way but have at least two co-owners who share the profits and costs of the business. The potential benefits of having more than one person running the business are obvious, but so are the potential costs. As co-owners, the partners each can make binding decisions that affect the partnership business. This means that your partner’s mistake could impact you. Partnerships, like sole proprietorships, do not enjoy any protection of personal financial assets from the business’s debts. So, partners may be liable for the business’s obligations. The structure is more complicated than sole proprietorships and requires more administrative work to remain in compliance with regulations. Partnerships enjoy the same tax benefits as sole proprietorships. Each partner, on their taxes, reports their share of the business and their profits. The business itself is not required to pay taxes but must report its income.
Corporations. A far safer, but more complicated, structure is a corporation. A corporation is the most complicated business structure and is subject to the most oversight and regulation. However, corporations almost completely protect their owners from financial liability. Further, corporations are able to sell stock and have a relatively easy time raising capital compared to sole proprietorships and partnerships. Tax liability for corporations is complicated. They can be taxed on their earnings and then the owners may be taxed on personal income, but there are ways to prevent this “double taxation.” One way is to make an election of S-Corporation status which passes federal tax liability on to the entity’s shareholders.
Limited Liability Company. The most well-rounded business structure is the limited liability company, or LLC. It protects its owners from financial risk (thus, limited liability). LLCs have more regulation and oversight requirements than partnerships and sole proprietorships but less than corporations. The main drawback of LLCs is that they are treated differently in every state. Each state has different operational requirements.
What is the bottom line?
There are lots of options for setting up a business, and not all of them are right for every business. None of them are fool proof. None of them are without operational challenges. After all, the owners are human – each with his or her own needs, wants and goals.
While it is important to be informed, there is no need for you to get a law degree to figure this out. Likewise, help is here and available to you. We live, eat and breathe this stuff. We can certainly figure out the best options for you.
Whichever structure you think is right for you, it would be a good idea to consult with an attorney prior to forming the business. An experienced attorney will help you to make the right decisions, guide you to the business structure that best suits your goals and needs, and can ensure that you are in compliance with all applicable regulation. This will set you on the right path, help you to have peace of mind and avoid costly mistakes.
A business attorney will also be there to help you every step of the way to advise you when it is time to make the changes businesses often need as they grow and mature.
If you are ready to start a business, or if your existing business has evolved and you are wondering if you need to make a change, please contact us to schedule a call with one of our business attorneys.