The First Consideration

Many people dream of one day owning their own business. Becoming a business owner can bring with it many rewards such as a sense of accomplishment, a feeling of fulfillment, and if you do well you may even earn yourself some extra income. As you can imagine, owning a business requires you to make many decisions. Quite often the first of these decisions is which business structure to operate as.

Most Common Business Structures

When people think of forming their own company, they should carefully assess the characteristics of one of the following structures:

• Sole proprietor
• Partnership
• LLC
• Corporation

Sole Proprietor

When you conduct business by yourself, you are operating as a sole proprietor. A simple example of this is reselling items on Amazon for a profit or being an independent contractor who performs services (driving for Uber is a common example). This form of business structure is the simplest, quickest, and lowest cost structure to operate under. It is common for people to operate as a sole proprietor when they are first getting started in business and want to test their idea before expanding their operations. It is very important to note, however, that when operating as a sole proprietor, you and your business are essentially one and the same. This form of business structure does not create a separate, distinct, legal entity and as such you may be personally liable for any of your business’s legal issues and debts. A sole proprietorship may still make sense if you operate in a low-risk environment or are planning on utilizing a different business structure in the near future. You can utilize a trade name to appear more professional, however, a trade name will not protect you from lawsuits or creditors. This lack of liability protection is a big reason why many business owners choose one of the other structures, such as an LLC or a Corporation. If you intend to operate under this structure, you should ensure that you have liability insurance that provides adequate protection. You should also consult with an attorney.

Partnership

A partnership is a voluntary association of two or more persons who decide to go into business together. An easy example of this is if you and a friend decide to start a lawncare business and divide the profits amongst yourselves. Partnerships can be created orally or by a written agreement. It is generally considered to be a good idea to get everything in writing as disagreements can arise and it is helpful to have a written record of what exactly you and your partner agreed upon. If you’d like to operate as a partnership, you should consult an attorney for help in drawing up your Partnership Agreement. Partnerships can have some additional complexity as a partner may choose to be a general partner or a limited partner. A general partner traditionally has a lot of control over the day-to-day operations. They tend to do more of the management and may enter into contracts that the other partners are legally bound by. As such, they have an increased level of liability for business obligations when compared to the limited partner. A limited partner on the other hand, typically invests money into the business but does not assume many of the management responsibilities. Their liabilities are generally limited to their investment in the partnership. If you intend to operate as a partnership, you should ensure that you have the assistance of a legal professional so that there are no grey areas in terms of the responsibilities and liabilities that you and your partners will face.

LLC

The limited liability company is a popular structure that is used frequently due to its flexibility. LLCs are formed by filing Articles of Organization with the Secretary of State for whatever state the owners choose. Typically, this is the state that you will be doing the most business in. Each state has its own laws regarding forming an LLC and so it is important to consult with a knowledgeable professional when setting out to create your LLC. In some states, creating an LLC can be as simple as filling out a short form on the Secretary of State’s website that asks for basic information, paying a small fee, and waiting for a few days. The Secretary of State’s website for your state will likely be a good starting point for you if you decide to go the LLC route.

LLCs typically have lots of flexibility compared to some of the other structures. Corporations have numerous legal requirements such as holding annual meetings and recording minutes; however, LLCs generally do not have this requirement. An LLC can be owned by one person, a group of people, or even other companies. LLCs also typically have a good deal of flexibility when it comes to taxes. Depending on the number of members and the elections that they make with the IRS, an LLC may be taxed as a corporation, a partnership, or as part of the LLC owner’s tax return. An LLC owner’s liability is also typically limited to their investment in the LLC. However, it is worth stating that for newly created LLCs with no form of credit history, lenders commonly require the owners to personally guarantee loans made to the LLC. Additionally, if your LLC is sued, your liability may not prove to be so limited. In some instances, a court may “pierce the corporate veil” and hold the company’s owners personally liable for the company’s actions or debts. This is typically done when the LLC is found to have engaged in egregious behavior. An LLC or Corporation that commingles the owner’s assets with the company’s assets, engages in fraud or other crimes, or uses the LLC simply as a way to escape creditors is setting itself up for its corporate veil to be pierced. Simply put, your company is meant to be a separate entity from yourself and as such you should treat it that way.

Corporation

You can think of a corporation as a separate, distinct entity that has many of the same legal rights of a real person. It is essentially an invisible person that exists within the law. A corporation has the right to buy and sell property, borrow money, sue or be sued, and enter into binding contracts. Corporations have strong legal protection; however, this protection comes at the cost of additional regulatory requirements. A corporation will have to submit Articles of Incorporation with the Secretary of State, hold annual meetings with minutes, elect a board of directors, amongst other requirements. As such, it is best to consult with an attorney when you are attempting to get started.

A corporation can raise funds through the sale of stock which can help it to expand its operations or finance some company purchases. It can also borrow money in its own name from banks or other lending institutions. When one of its shareholders dies, the corporation generally keeps on going without much disruption which is one of its advantages when compared to a sole proprietorship or partnership. A major drawback, however, is the existence of double taxation. A corporation generally pays taxes on its earnings, and the shareholders pay taxes on money distributed to them in the form of dividends. Essentially, the final payout to the shareholder has been taxed twice which is about as appealing as it sounds. Still, for many business owners, the benefits of a corporation outweigh these costs and as such corporations are widespread throughout the world.

What this means for you

Your business structure will ultimately be a decision that you make after careful consideration of the various pros and cons associated with each option. When weighing your options, you should consult with relevant professionals to ensure that you are well informed of any potential drawbacks or legal requirements. We hope that this article has helped to clarify some of the options out there for you and your soon to be successful business.

If we missed anything or you’d like us to do a deeper dive into something else let us know!