What’s the Best Business Structure

Before you begin your new venture, you will have to determine what type of company you will be. There are several different forms of legal business structures all with their own pros and cons. You will have to determine which entity will best suit your venture, for not all businesses have the same needs. If you are selling a single product or service exclusively through the internet, then a sole proprietorship might be all you need.

If you plan on selling a variety of goods to a variety of markets, you may need something more complex like an LLC or Corporation. Below are the different types of business entities, how they are set up, and their advantages and disadvantages as well as how they are taxed.

Business Legal Structures

  1. Sole Proprietorship: The sole proprietorship is the easiest legal entity to start and maintain because it is owned and operated by only one person, the entrepreneur who then becomes the owner. The business has no separate identity outside the owner. The owner takes complete liability for the business and is entitled to 100% of all profits. This entity is best for small businesses which will be localized or singular in scope and needing limited capital to start-up.
    • Pros: Easiest and cheapest to form; no corporate business taxes; full authority; keep all profits; little to no government control over operations
    • Cons: Unlimited liability – the owner is personally responsible for all debts – personal assets can be seized and sold to force payment of business debts; less capital available; limited to the skills and knowledge of the owner
    • How to start: File for local and state licenses; pay the appropriate fees
    • Taxes: The owner pays self-employment tax (including social security and Medicare taxes) on all profits.

     

  2. General Partnership: A general partnership is more relaxed and informal than the limited partnership. A partnership consists of two or more individuals who come together by contributing money, time, expertise and resources to begin and operate a business. Unless stated differently, the partners have equal share. Most general partnerships create a formal partnership agreement laying out each partner’s contribution and responsibilities though it is not legally required. A verbal agreement between partners is all that is required to do business. This entity is best for entrepreneurs who have one or two investors or business partners and a business that will be limited in scope. Generally one partner is designated the General Partner who oversees the business operations. All partners have personal liability in the company.
    • Pros: Easy and cheap to form; no corporate business taxes; little to no government control over operations
    • Cons: Unlimited liability – at least one partner must take on personal liability for the business; difficult to raise capital outside of partners’ personal contribution; partners must be bought out or else partnership must dissolve
    • How to start: Generate partnership agreement; file for local and state licenses; pay the appropriate fees
    • Taxes: Each partner must pay self-employment taxes on their share of the profits, whether or not the profits were disbursed out of the business.

     

  3. Limited Partnership: The limited partnership is similar in make-up to the general partnership in that two or more owners invest in and operate a business. However, not all partners are created equal. In this entity, usually one or more partners become general partners and manage the business while the other partners are ‘limited’ partners, meaning they contribute capital and share in profits but have no say in the management of the business. The general partners take on liability for the business, while the limited partners are protected from personal liability. They only are responsible for their partnership obligations as laid out in a partnership agreement. This entity is best for entrepreneurs who seek to find investment capital for their business. Investors can participate in profits without the duties of managing the business and the risk of liability.
    • Pros: Limited partners can partake in profits without being involved in the business; general partner(s) still maintain control; attractive to investors; can write off loses; limited partners have some liability protection
    • Cons: Liability for the general partner(s); all partners must pay income tax on all profits
    • How to start: Must file formal certificate with the Secretary of State that sets forth terms of operation; pay appropriate fees
    • Taxes: Each partner must pay taxes on their share of the profits, whether or not the profits were disbursed out of the business

     

  4. Limited Liability Partnership (LLP): The LLP is a partnership in which all partners are limited partners and enjoy personal liability protection. The limited partners have only partial liability for business debts, and are not held liable for actions and wrongdoings of other partners. The LLP is a more formalized structure that has a flow-through tax – meaning individual partners pay personal income tax on their earnings and the LLP pays no taxes. This entity is popular for businesses that want a more formal structure and need liability protection yet like doing business as a partnership.
    • Pros: Business does not pay taxes; limited liability for all partners
    • Cons: There still remains some liability for debts beyond a partner’s initial investment
    • How to start: Must file formal certificate with the Secretary of State that sets forth terms of operation; pay appropriate fees
    • Taxes: Each partner must pay taxes on their share of the profits, whether or not the profits were disbursed out of the business

     

  5. Corporation (C-Corp): A corporation is a completely separate entity from the individual owners. To form a corporation the investors, or shareholders, must transfer in capital to the business in exchange for stock. Once stock is created, the Secretary of State must approve the formation of the entity and issues an approval called a charter. Corporations must be overseen by a board of directors who serve the interests of the shareholders. Shareholders have liability which is limited to their investment. A corporation pays taxes entity, then the individual shareholders pay income taxes on any profits they are disbursed. Thereby profits are essentially taxed twice.
    Corporations have the greatest ability to raise extensive amounts of capital for a business and the expertise of the various shareholders and board members can strengthen the framework of a company. Entrepreneurs who have a large-scale venture with a large scope are best to look into creating a corporation.

    • Pros: Liability protection; ease in raising capital; management overseen by board of professionals; capacity for large-scale business operations
    • Cons: Highest start-up costs of any entity (can be between $2,000-5,000); high annual fee; double taxation on profits; subject to federal regulation and control; activities are limited to what is laid out in the charter
    • How to start: Issue stock to shareholders in return for capital investment; file for charter with Secretary of State; pay for start-up costs to lawyer and accountant; pay appropriate filing fees
    • Taxes: Corporation pays business tax; shareholders then pay personal income taxes on any salaries and disbursements

 

  1. Limited Liability Company (LLC): An LLC is an unincorporated association. It has the tax benefits of a partnership but the limited liability protection of a corporation. The LLC itself does not pay taxes so there is no double taxation. The profits pass through to the owners who pay their own personal income tax. All members can participate in management of the business. The LLC has been gaining in popularity over the last few years because it has the most options available. There is no limit to the number of members, and other corporations or partnerships can be a member. The LLC also has little drawbacks other than the annual dues which equal that of a corporation in some states. This is a great business entity for most entrepreneurs who desire a varied business structure.
    • Pros: Liability protection of corporation; no double taxation; can have foreign members
    • Cons: Start-up costs and annual fees higher than partnerships; Rules vary from state to state so harder for businesses doing business across state lines
    • How to start: Must file formal certificate with the Secretary of State that sets forth terms of operation; pay appropriate fees
    • Taxes: Each LLC member must pay personal income taxes on profits

     

  2. S Corporation (Subchapter S): Derives its name from Subchapter S of the Internal Revenue Code. This provision allows for an S Corporation to have the liability protection of a corporation, but the business does not pay its own income taxes. The corporation must follow strict guidelines for operating. Only individuals can be shareholders, and the corporation must be completely domestic. The greatest benefit of an S Corp form an investor perspective is that it allows shareholders to offset income with business losses, and taxes can be deferred on retained earnings. This entity is good for small businesses who are looking to have a formal structure, are localized in the United States, and are looking to have increased tax benefits.
    • Pros: No double taxation; liability protection; many tax benefits for shareholders
    • Cons: Strict guidelines for operation; Only individuals can be shareholders (not other corporations or partnerships); can only be domestic; no more than 75 shareholders
    • How to start: Same as corporation
    • Taxes: Individuals pay income taxes similar to a partnership

Deciding what entity to start is the most important decision an entrepreneur will make. It is imperative that you decide what entity will best suit your needs. The size and scope of your business, as well as the amount of money need will be the biggest factors in determining which entity to choose. It is best to seek outside legal advice to fully understand the implications of your chosen entity.

The preceding was an excerpt from the Certified Entrepreneur Training Program, by Erik Bowman

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