While it may be easy to create the name for your dream business or decide on what products or services you are going to offer, choosing the proper business structure is much more difficult. How you legally register your business will largely depend on who is involved and the type of business you want to run.
For the most part, an individual business owner can have a sole proprietorship, corporation (C or S), or limited liability company. A company with several owners can be a general partnership, corporation, or Limited Liability Company (“LLC”).
With many options, it can seem overwhelming to decide how you want to run your business before you have even started your first day of operations. Below we discuss each type of business structure, the pros and cons associated with them, and how to choose the structure that best suits your needs.
Sole Proprietorship
This formation is the easiest, least costly, and least regulated form of organization for an individual business owner.
Pros:
The only required legal action to form this business structure is to begin operations. To help matters as your business grows, you should file a fictitious name registration form in every state that your business will operate. Additionally, check the zoning and licensing laws for the location of the business. Finally, to save your intellectual property, trademark and/or copyright all marketing materials.
Because of the nonexistent legal fees and lows costs involved when starting a sole proprietorship, most individually owned businesses choose this option.
Cons:
Under a sole proprietorship, the individual owner is entirely responsible for all lawsuits or claims made by customers, employees, or vendors. This shows that while there are little legal fees associated with creating this business, there are just as few legal protections.
General Partnership
A general partnership business structure is similar to the sole proprietorship in that it is fairly easy to form. The only action necessary to start a general partnership is that two or more individuals engage in a business activity that attempts to make a profit.
Pros:
Expenses and profits do not need to be shared equally. This allows one individual to make 70% of the profits and the second partner to make 30%. While there are no formal requirements, to mitigate potential conflict, a general partnership should include a written partnership agreement. Another similarity to a sole proprietorship is that this agreement is not taxable as a business “entity.”
Cons:
Just as with the sole proprietorship, the partners of a general partnership have unlimited personal liability if sued. In this case, the financial liability extends to both partners in the agreement. Even if only one member of the partnership is the reason for the lawsuit. Finally, the death or withdrawal of one of the partners causes a complete dissolution of the general partnership.
Corporation
A corporation is similar to a partnership in that most—if not all—of the shareholders participate in managing the company.
There are two types of for-profit corporations, the “C” corporation and the “S” corporation. The difference between the two types has to deal with the IRS statutes that lay out the different tax treatment for the two types of businesses. A “C” corporation is typically utilized by larger business entities. Under this structure, a company must pay corporate taxes on profits while the shareholders are also required to pay taxes. Smaller businesses tend to choose an “S” corporation business structure. An “S” corporation does not have to pay taxes on company profits. Rather, business profits and losses go to the owners of a corporation.
Pros:
The management style of a corporation is similar to a partnership. Each shareholder or owner of the corporation only has limited liability for the actions of the other owners.
Furthermore, corporations offer additional advantages as members avoid personal liability for business debts and court judgments. Thus, if a creditor is trying to collect on payments, they can only seize assets owned by the business and not the personal assets of the shareholders or owners.
Another point that separates a corporation from a general partnership is that no matter if a member passes away or leaves the business, the company is its own legal entity as it is separate from specific shareholders. This means that the business continues regardless of who owns the shares.
Corporations also often have a more favorable tax rate structure. The business structure is such that owners of these businesses can save their profits to employ more employees. Another tax benefit of a corporation is that tax deductions are available for the health or other benefits are given to employees and owners.
Cons:
The costs and legal work required to correctly set up either variation of a corporation is the largest disadvantage associated with this business structure. The costs associated with the start of a corporation depend on what state or city the business will be headquartered. However, these fees can be as high as several hundred dollars. Finally, corporations must hold annual board and shareholder meetings. On top of the cost associated with this event, the minutes of the meeting and shareholder actions must be recorded.
Limited Liability Company
The Limited Liability Company (LLC) business structure incorporates the best characteristics of both a general partnership and corporation.
Pros:
Owners of an LLC are members. These members have a limited liability which mimics that of shareholders to a corporation. Aside from liability, the LLC is a partnership.
Another benefit of an LLC is that this business structure can have each partner be a part of the management process, or the company can have a single manager. Two distinct characteristics of an LLC that separate it from a corporation is that there normally is not a board of directors and the structure does not require annual meetings and minutes.
The tax benefit of an LLC is that the company earnings go through to the owner’s personal tax returns. Thus, the company itself is not experiencing taxes as a separate entity. Finally, the percentage of profits received does not equate to the voting power of members. Thus, one owner could receive 40% of the profits while only having a 10% vote in company matters.
When properly used, an LLC can be the best business structure and offers almost no downside.
If you have any questions regarding how to choose the best business structure for your needs, Antonoplos & Associates can help.