Starting a business can be exciting, but also scary and confusing. While you don’t need formal business training or an MBA degree to start and grow a successful business, there are some critical choices you’ll need to make from the beginning, one of which is choosing your business structure.
Careful consideration of which business structure is right for you during your company formation can have several implications on your taxes, business and personal finances protection, and long-term plans. So, how do you choose the right structure for your company?
Understand Your Options
In general, you can choose from several types of business structures. These include:
1. Sole Proprietorship
If you do business activities, but don’t register as any other form of business, you’re automatically considered a sole proprietorship. This is true whether you operate it in your own name or its trade name.
The main advantage of setting up as a sole trader is that it’s fairly inexpensive and simple. You don’t need to file paperwork for setting up another entity since you already exist. That said, being a sole trader can have several disadvantages. For one, there’s no legal separation between your personal assets and your business’s assets. Also, most banks are more reluctant to lend money to sole traders, making it difficult to raise money.
2. Partnership
Maybe you started your business with a loved one or a friend? In this case, a partnership is a good option for businesses with multiple owners. In general, there are two types of partnerships–limited partnerships and general partnerships. In a limited partnership, only one partner has complete control of operations, while the others contribute to and receive a share of the profits. Meanwhile, a general partnership means that all are equally shared.
A partnership can operate as a sole proprietorship where there’s no legal separation between the owners and the business. However, they can also become limited liability partnerships, depending on the liability structure and funding.
A partnership is easy to form and has better growth potential than sole traders. However, it’s more expensive than a sole proprietorship since you’ll need a lawyer to review the partnership agreement and provide legal advice and services.
3. Limited Liability Company
A more popular choice for owners looking to take their business to the next level, an LLC is very easy to form and has no limits on how many shareholders you can have. This is critical in your plan to pursue investors.
The biggest benefit of LLCs is that they provide business owners the same liability protection as corporations while allowing profits to pass through to the owners as income on personal tax returns. That said, with added protection comes more difficulties in formation.
4. Corporation
Corporations are a more formal type of business structure and are divided into three categories–C corporations, S corporations, and B corporations. They are characterized by a more complex legal structure, shareholders, and intricate tax requirements. Thus, they are most suitable for larger and more established businesses, with numerous outside investors and employees who intend to sell stock in their company.
With this business structure, you’ll have the most limited liability possible and have more potential to increase capital. That said, corporations are complicated to set up and may incur double taxation.
4 Factors To Consider
1. Flexibility
The best structure should support your business’s potential for change and growth. So, think about how your business will grow in the future and decide which type of business structure can allow for that growth you envision. Turn to your business plan and review your goals to determine a structure that best aligns with your objectives.
2. Legal Protection
Separating your business assets from your personal assets is beneficial if your company carries significant liability. The more protection you want, the more formal your business structure should be. If so, you can choose between an LLC or corporation for the liability protection they offer.
3. Owner Number And Type
If you’re planning to go public in the future, you need to establish a C corporation from the start. However, if you have a business you don’t want to go public, then you’ll need to choose based on the number of owners. A sole proprietorship can only have one owner, while the rest can have multiple owners.
4. Taxes
In terms of taxes, sole proprietorships, LLCs, S corporations, and partnerships are pass-through structures. This means that profits are only taxed when they’re paid out to the owners. C corporations, on the other hand, may experience double taxation. Double taxation occurs as corporations, who are taxed on their annual earnings, pay out dividends to shareholders, who themselves are also taxed on the same source of income on a personal level.
Takeaway
Choosing the right legal business structure is a critical part of running a business. Whether you’re just starting out or ready to take your business to the next level, you need to understand your options to better protect your company. Hopefully, this article has helped you decide on the best business structure that makes the most sense for your company.
Keep in mind, though, that you can always opt to change your business’s existing structure if you think that another type would be more beneficial to you or your business.
