Choosing the right business structure is one of the first things you should figure out when acquiring a new business.
Your business structure will affect your personal liability, your taxes, and your financing every step of the way.
Here’s a guide to help you understand how to choose the right type of business structure and why this is so important to your success.
Types of Business Structures
Should you incorporate right away, or start out as a sole proprietorship?
How complicated will it be to have a partnership?
Having a clear understanding of each type is essential as you work through this decision-making process.
Consult with a trusted business attorney to build a solid foundation and protect yourself from making costly mistakes…
Sole proprietorships are the most common types of companies as they are simple and involve very little in the way of overhead or administrative costs.
Here, one person is in charge of all operations, which tends to keep things simple on all levels.
Tax-wise, this type of business structure is generally appealing because it’s reported as a part of your personal income taxes, but your business earnings are only taxed once. Though taxes can be high, you can pay them in quarterly installments to stay on track.
The main drawback with a sole proprietorship is that the owner is, by default, personally liable for all debt and assets involved in the company.
Corporations function as their own legal entities which are separate from owners. As such, they can be held legally responsible, and owners aren’t personally liable.
Corporations offer a bigger range of tax options than proprietorships or partnerships, and this will differ depending on whether you have an S corporation or a C corporation.
How to incorporate:
- Contact relevant state office to register
- Get a business attorney
- File for incorporation
- Prepare information for your certificate of incorporation
- Draft articles – eg: shareholder agreement
Once completed, the secretary of state will send you a formal certificate of incorporation.
All owners in a corporation must follow rules strictly as stated in both the articles of incorporation and relevant laws.
Accurate records and reporting are essential, including shareholder activities.
Learn more about The 5 Biggest Mistakes to Avoid When Starting Your New Corporation
Limited Liability Company (LLC)
LLCs are popular options for many US small business owners and may be the best choice in terms of taxation and liability protection.
LLCs are similar in structure to S corporations, but there is no limit on the number of shareholders with an LLC.
With an LLC, any owner can have full ownership of the organization, and asset distribution may be more flexible than other formats. But if you want stock certificates or stock shares, you’ll want to form a C corporation.
Setting up an LLC requires filing articles of organization with the state, and in some cases, drafting an operating agreement. Administrative and organizational costs may be higher with this type of company.
In addition, there are varied tax treatments (per state) and so companies operating in multiple states will face this extra complication.
A partnership may be general or limited, where limited partners are investors with no control over business activities.
In a general partnership, two or more people share the ownership and management of the business.
The benefit of a partnership is that it does lead to tax burdens for the business itself. Instead, profits and losses are passed through individual tax returns. Each partner files a schedule K-1 as well as reporting profits on tax returns.
Personal liability is the key drawback here, where each partner is personally liable and responsible for reporting details on individual returns.
New businesses mostly should consider a general partnership as it involves a lot less in the way of paperwork.
Considerations for a partnership:
- How much is each partner investing?
- How much is each partner involved in day-to-day operations?
- What if one person leaves?
- How exclusive are the intellectual property and related matters of confidentiality?
- How will you resolve conflicts?
If you decide to move forward with a partnership, we can help you draft a legally binding partnership agreement.
Choosing the Ideal Business Structure
Here are some questions to consider as you move towards this important decision:
- How much does each owner need to be protected from liability?
- What is your administrative budget?
- How might the structure need to shift if your business grows rapidly?
- How can you minimize taxation?
- What happens if you are no longer running the business?
- How flexible do you need your business structure to be?
- How many owners and/or shareholders are involved?
Remember that things will change — both in your business and externally — which can affect the way you run things.
With any luck, your business will grow and scale and you’ll need to shift your business structure into something more fitting to a larger organization.
Get familiar with your options as early as possible, and get legal counsel to protect and guide you.
Call us or schedule an appointment today for more information.
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