You’ve found your idea, worked out the finances, discovered your competitive advantage, decided on a funding method, and now its time to get to work on actually making your vision a reality. The next step is to decide on a business structure. There are many routes you could go and no real one size fits all. Some are better on taxes, some limit your liability, others give you more control. So which one is right for you?
The most common business structure type is a sole proprietorship. Usually, sole proprietorships tend to be smaller in scale than other business structures, but there is no law limiting its size.
Sole proprietorships are owned by a single person. They don’t act as a separate entity, so all the business and tax liability are your own if you choose to go this route.
It can be a good option if you are looking for full control of your business and you are okay with that liability.
A partnership is a business that is owned by more than one person or business. The ownership doesn’t have two be 50-50 either. It can be any combination of percentage which is agreed upon by its members. Each member would get a K-1 for their taxes, splitting income and equity according to their contributions and operating agreement.
There are different forms of partnerships which are general, limited, and limited liability partnerships.
General Parthership (GP)
In a general partnership, all partners share in the profits, responsibilities, and liability for debts. They also have a responsibility to act in the best interests of the other partners.
Limited Partnership (LP)
A limited partnership is different from general partnerships in that partners can have limited liability. That means that they aren’t able to loose more than they put into the business. In other words, they are not liable for business debts that are greater than their contribution. These are sometimes known as silent partners or can be angel investors.
So, general partners manage the day to day business and are liable for company debt including litigations. Limited partners just contribute financially to the business as an investor.
Limited Liability Partnership (LLP)
A limited liability partnership is a type of structure where all partners have a limited liability, unlike a general partnership or LP. All partners are may also be active in the business.
This structure is often found in professional services where partners may want to limit their responsibility from litigation arising from the conduct of other partners.
A C corporation is a separate entity from its owners. For most purposes it is its own person, so these grant you the greatest protection in terms of individual liability.
The downside is that corporations are taxed as their own entities. So, as an owner you may pay taxes on your income from the business, and the business will have to pay taxes on its income.
Corporate taxes can become extremely complicated very quickly so it may be more costly in its need for a dedicated accountant as well.
An S corporation is a type of structure where profits and losses are passed through directly to the owner’s personal income. This means that it isn’t subject to corporate tax rates. This is an election which can allow you much of the benefit of a C corporation without the double taxation.
There are restrictions regarding S Corps. For example, members must be US citizens and an S Corp can only have a maximum of 100 shareholders.
Limited Liability Company (LLC)
A limited liability company, or LLC is another very common structure for small businesses. An LLC gives you a good mix of the advantages of the sole proprietorship, corporation, and partnership business structures.
An LLC is its own entity and therefore provides you with liability protection like corporations but does so without double taxation. Your business can avoids double taxation since by can passing through taxes to your personal income.
LLCs are treated differently in for tax purposes in each state, so tax liabilities vary depending on where you are. Check with your state for specific LLC regulations.
Choosing your business structure
As you select a business structure, be sure to choose the one that provides the most benefits and is the best structure for your small business.
Some things to think about as you weigh your options:
- Legal liability
- Your long term plans
After you decide on your business structure, check out your state’s website or talk to an accountant about registering your business and moving on to next steps.