Choosing Which Business Structure is Right for You
One of the most important choices you will make, after deciding to start a business, is deciding which legal structure is right for you. This decision will impact your future liability, the amount of control you will be able to exercise, how complex the requirements will be, and much more.
Because this is not a decision to enter into on a whim, the following will briefly describe the different types of business entities as well as the factors you will want to weigh to find which structure is right for you.
Types of Business Entities:
A sole proprietorship, the most common form, is an unincorporated business that is owned by one person. This form offers complete managerial control to the owner and is often associated with easy setup as little paperwork is necessary when there are no partners or executive boards to contend with. A sole proprietorship also has low costs. The only fees generally associated are license fees and business taxes.
A main advantage of this structure is that income and expenses from the business will be included on your personal income tax return, so business earnings are only taxed once. Another advantage is that as the sole owner you can dissolve your business at any time you wish without having to file formal paperwork. A drawback with this structure is that raising money can be difficult. There are no stocks like in a corporation to raise capital and banks are hesitant to give business loans based on one line of credit. However, the main disadvantage with this form is that you, as the owner, will be personally liable for all financial obligations of the business. Embracing full liability means your own personal assets would be at risk of satisfying potential business debts.
A partnership can be created with two or more people who agree to share in the profits and losses of the business. A partnership doesn’t pay tax on its income as profits and losses will be “passed through” to partners to report on their individual income tax returns. Partnerships are also on the easier side of the spectrum to form with only a few key documents (ex: Certificate of Partnership) necessary to file. Another benefit with this form is that it is easier to obtain a business loan when there is more than one owner.
There are two different types of partnerships, a general partnership and a limited partnership.
Each partner manages the company and assumes personal responsibility for the partnership’s debts and obligations. Thus, each partner can act on behalf of the partnership, take out loans, make business decisions, and puts their own assets at risk to fulfil obligations.
Most often will have one general partner who operates the business, enjoys complete control over decisions, and assumes full personal liability. The remaining partners are limited partners who serve as investors, have no control over the partnership and are not subject to the same level of personal liability.
Forming a corporation, a complex structure, is a much more expensive undertaking. A corporation is a separate entity from its owners and thus requires compliance with many regulations. However, as a legal entity, a corporation can be taxed, can make a profit and can be held legally liable for its actions. Because the corporation is held liable, the debt of a corporation is not considered to be that of its owners, so the owners avoid personal liability and are not putting their own assets at risk. The next advantage of this form is the ability to raise capital by selling stock. Another benefit is that corporations can continue indefinitely. The life of a corporation is not affected by the death or transfer of shares by its owners, a problem that other structures must deal with.
Due to their complexity, corporations are more expensive to form and require extensive record keeping. The owners of a corporation also pay a ‘double tax’ on the business earnings. The double tax means the corporation’s earning are taxed at the corporate level and then earnings distributed to shareholders are taxed at individual rates on their personal income tax returns.
The above describes the common C-Corporation. The advantages and disadvantages will fluctuate based on the other corporation structures.
Limited Liability Company (LLC)
A limited liability company (LLC) is a hybrid entity that blends the advantages of both a corporation and a partnership. Akin to the partnership structure, profits and losses of the LLC are “passed-through” to the owners’ personal income tax return without taxing the business itself. But unlike the partnership and more like a corporation, the owners of an LLC are shielded from personal liability. Any member or owner of an LLC is allowed a full role participating in the business operation and notably a member can be an individual, a partnership, or a corporation. Another advantage of this structure is that profits and losses can be distributed in a flexible manner meaning they don’t have to be distributed in proportion to the capital contribution each member puts in.
Choosing your business structure depends upon your thoughts on:
- How much liability you are willing to accept
- Whether you prefer double taxation or pass through taxation
- Whether you want sole control of the business, share control with others or relinquish control to a board of directors
- What type of formation and administration formalities you are willing to do
- Your future needs
Deciding what type of If you have questions about forming a business requires a lot of thought and consideration, If you need help choosing which legal structure is right for you, please contact Windrose Law Center PLC at 602-457-1846.
By: Dylan Wilson, Law Clerk, Windrose Law Center PLC