What's the Best Legal Structure for My Business?
Legal structures play a huge roll in your business’ journey, and choosing the best one could have real positive implications for your business. You must put in time and consideration before making this decision given that there are different types of business entities, each with significant pros and cons.
The way your business functions aside, this choice will impact your legal liability and how your business deals with taxes.
When thinking about the best legal structure for your business, it’s important to choose one that gives your business the advantage. (Think about how you want to grow and what will be the most financially conscious choice for your taxes!)
Let’s get familiar with the most common legal business structures or business entities.
Popular types of business entities
1. Sole Proprietorship
This is the simplest form of a business entity where one person is solely liable for all the operations of the business. For people who look forward to being their bosses, a sole proprietorship would be the perfect business entity to put them in control. However, this entity does not offer the protection or separation of personal and professional assets, which will become an issue as the business continues to grow.
Partnership is a business entity that’s owned by two or more people. There are two types of partnerships: general partnerships and limited partnerships. These two are differentiated by the power that a partner has in the partnership. Depending on the liability structure and entity’s funding, partnerships can carry a dual status as a limited liability partnership or sole proprietorship. Ultimately, partnerships allow partners to make decisions together and share profits and losses together.
3. Limited Liability Company (LLC)
An LLC is a hybrid business entity that allows shareholders to limit their personal liabilities while they enjoy flexibility and tax benefits of a partnership. LLCs protect shareholders from personal liability for business debts so long as their activities are legal, ethical, and responsible. In terms of protection and separation of liability and assets, LLCs offer more than sole proprietorships.
If you’re starting a business, at the very minimum, you should be forming an LLC to make sure your business is recognized as a separate entity than yourself.
A corporation is regarded as a separate entity from the owners by the law. It is deemed as a person, with its legal rights. It can therefore sue, be sued, own property and sell it and also sell its rights of ownership in the form of shares.
There are two types of corporations generally chosen for small businesses: S-Corps or C-Corps.
Depending on how much revenue your business generates, it may be valuable to structure as an S-Corp over an LLC because S-Corps are what we call “pass-through entities”. There is a lot to be said about this, but the most important thing to know is that it offers some serious tax benefits you can’t get with an LLC.
In terms of ownership, a cooperative is owned by the people it serves. It gives its members the power to vote on the entity’s leadership, mission, and direction.
Factors To Consider When Choosing A Legal Business Structure
For new businesses, it could be tricky to choose the legal business structure. Depending on where you want your company to be headed, it is important to choose a legal structure that will allow your business some room for change and enable your business to align with its goals properly. Most importantly, the legal structure you choose must allow your business to grow and change without limiting its potential.
Business owners looking for simple start-ups and minimal complexity are best suited to sole proprietorships. All it requires is the registration of your name, do business, report on the profits made and pay taxes on the personal income. As much as it eliminates complexity, sole proprietorships have limited options for outside funding. Partnerships, on the other hand, should have a signed agreement between the partners, stating clearly their roles and their profits share. LLCs and corporations have detailed reporting requirements to the state and federal governments.
Business entities, such as corporations, carry the least personal liability since they exist as separate entities from their owners. LLCs offer the same protections for their owners but enjoy the tax benefits of sole proprietorships. In partnerships, the partners share the liability as agreed upon in the partnership agreement.
For sole proprietorships and LLCs, all profits are considered personal income and are taxed annually. Business owners who are keen to avoid double taxation may find an LLC the perfect business entity to adopt to avoid being taxed as a company and as an individual. Partners in a partnership so claim their profit shares as taxable personal income. Corporations file their tax returns on the profits after expenses.
Individuals who focus on having the primary control of a business may consider taking up sole proprietorships or LLCs. Such individuals can also negotiate their positions in a partnership. Corporations are structured to have a board of directors and do not support the control of a single person as such.
6. Capital Investment
Whenever you are looking for outside funding from investors or banks, sole proprietorships are not the best; you would stand a better chance with a corporation. Corporations have a wide source of capital such a stock sales while sole proprietorship’s capital sources are limited to personal accounts while partnerships depend on their partners’ contribution.
7. Permits, Licenses, And Regulations
Different business entities may require specific permits and licenses to operate. Depending on the activities of the business you choose, you might be licensed to operate at a local, state, and federal levels.
Different legal business structures are available for business starters to choose from, depending on the activities they intend to carry. One may choose to adopt any business entity depending on flexibility, the complexity of the business, and other factors. Whichever the legal business structure you adopt, ensure that it supports business growth and development. You can change your mind down the road, but there can be a lot of paperwork involved. Contact your CPA for solid advice into which business structure is right for your company and your goals for growth.
Meet the Author: Shauna Armitage
Shauna is a Marketing Director or Fractional CMO helping early-stage startups scale with effective strategies, creative solutions, and unparalleled integrity by making the most of small budgets for maximum impact.
As a vocal advocate for women in business, Shauna is on a mission to redefine what it looks like to be a working woman and to support other women doing the same. She spends her free time traveling with her husband and four kids while drinking Coca-Colas. Connect with her on Instagram at @shauna.armitage.