What is the most appropriate legal structure of a startup?
Starting a new business can be challenging, even for experienced entrepreneurs. All startups should establish strong foundations to be legally and financially protected in the long term.
Choosing a structure is vital because it will affect your day-to-day operations, decision-making processes, and more.
Factors to Consider When Choosing the Legal Structure of a Startup
The first thing any startup owner should do is establish business priorities and goals. Your startup’s ideal legal structure will depend on the nature of your business, how high risk it is, and how likely it is to grow.
- How flexible is your business now and into the future?
- How complex is the organization?
- What type of financing are you eligible for?
- What are the costs (operational, overhead, etc.)?
- Who are your existing or potential partners, shareholders?
- How much risk can you / the business reasonably take on?
- How can you avoid unnecessary taxation?
- What are some regulations specific to your region and industry?
- How much operational control do you want/need?
- Are there any licensing or permit regulations you need to handle?
Consult a CPA and attorney early on to help you choose from the various legal structures for a startup. They will be able to clarify your questions, as well as handle necessary paperwork like contracts.
Choosing the Legal Structure of a Startup: What are the Options?
Here’s an overview of the main types of business structures and their advantages:
Sole Proprietorship
This type of business is run by a signal owner who is responsible for all debts and assets. A sole proprietorship is a simple option for those who are new to business.
The main drawback for a sole proprietorship startup is that the owner is personally liable. And tied into this is the fact that the owner may not be able to raise the level of financing of a partnership or group of owners.
To start a sole proprietorship, you must register with the Secretary of State.
Some advantages include:
- Simple to open
- Few legal requirements
- Low cost
- Low risk
- Easy to dissolve
Partnership
A common choice for a legal structure of a startup is a partnership. The critical disadvantage here is that partners are liable for business debts and judgments. To avoid this, you may choose to enter into a Limited Liability Partnership.
Another disadvantage is that there may be restrictions on transfers when it comes to buying and selling. These restrictions will be outlined in your partnership agreement.
Partnerships are mostly advantageous for startups — here are some benefits:
- Minimal formalities
- Easy to terminate
- A lot of flexibility
- “pass-through” tax liability
- Simple to set up
- A bit of paperwork but not much
- File a Certificate of Conducting Business as Partners
- Draft an Articles of Partnership Agreement
- Get a business license
- Easier to get financing
- More potential for growth
- Possible tax deductions
- More experience
Limited Liability Company (LLC)
An LLC combines the concepts of partnerships for tax purposes and corporations for liability purposes.
Here are some features and advantages:
- LLC’s are created by filing Articles of Organization with the Secretary of State.
- Owners are members who may elect or hire a manager(s) to run the business.
- Governed by an operating agreement which is the official rules
- Members are not liable for business debts and legal judgments of the LLC.
- No restrictions on the number of members
- Members can be individuals or other businesses.
- “Pass-through” tax liability
- Profit and losses can be passed on to members as they choose
When it comes to the legal structure of a startup, the main drawback with an LLC is that the operating agreement typically will have restrictions on buy/sell provisions.
Corporations
A corporation is its own entity, not tied to personal ownership. It can sue and buy and sell property and stocks. The advantage for owners is that they are not held legally responsible or liable, should something go wrong.
There are different structures of corporations. Depending on the type of structure, there may be tax advantages but also limitations.
Be sure to consult with both a business lawyer and CPA if you are considering incorporating.
Most startups will not be at the stage where a corporate structure is the best option, but it’s not a bad idea to consider as a future goal.
Here are some common mistakes you’ll want to avoid if starting a new corporation.
Contact a Reputable Business Lawyer
With help from the right professionals, your startup will have a strong foundation, which paves the way for resilience and growth.
A business lawyer can help you understand how the legal structure of a startup can impact business operations today and well into the future.
Click here to schedule a 30-minute consultation or call 1-855-976-3783 for more information.
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