The type of structure that you choose is a major decision in opening your new business. It will be based on where you plan to obtain funding, how you are legally bound to the business and your tax structure. In turn, this determines how personally liable you will be regarding any debts and legal issues.
Below are some of the basic types of business structures and some possible pros and cons of each. It is also highly recommended to seek advice from a legal office or professional accountant to ensure that you are making the best decision given your personal situation.
Sole Proprietorship
A sole proprietorship is the simplest, yet riskiest of the business models. You are solely responsible for the business, so you get to make all the decisions and are entitled to all the profits. However, you are also responsible for all the debts and liabilities.
Pros
- Sole proprietorships are the simplest entity to set up.
- You have complete control over the money and therefore get to make all the decisions.
- They enjoy a simpler tax structure, as your income is tied to the business income. You can also pay anticipated taxes quarterly, instead of in just one lump sum at the end of the year.
Cons
- You are personally liable for any debts or legal actions claimed against you.
- Unless you have the money already in the bank, it may be difficult to raise the funds you need, as many may consider the investment a risk.
- Being solely responsible for the business is a heavy burden and can be very stressful. Trying to run a business alone often affects one’s personal life, as there is little to no work-life balance.
Partnership
A partnership is just what it sounds like – two or more people sharing ownership of the business. The responsibilities, profits, liabilities, etc. are equally distributed unless outlined differently in the agreement.
Pros
- Like a sole proprietorship, partnerships are fairly easy to set up.
- You will have partners to help you raise capital, make decisions, and share the workload.
- Taxes are passed through the owners as profits or losses, which makes filing taxes easier and avoids the double taxing that a corporation must pay.
Cons
- You and your partner(s) are personally liable for any debts or legal actions claimed against you.
- Often, there is tension between partners in making decisions, pooling financial resources, and expectations of performance and responsibilities.
- Should there be an unsolvable disagreement, the partnership will be terminated if one partner leaves without buying out the other partner’s share of the business. It is wise to determine fair terms in writing prior to going into business, regardless of how much you trust your partner.
Corporation
A corporation is its own separate, legal entity. Although all of the decisions for the corporation are made by shareholders and/or a board of directors, these people are not held liable for legal actions or debts incurred by the corporation.
Pros
- You will not be held personally liable for any debts or legal actions claimed against you.
- Generally, it is easier to obtain funding, as the risk is lower for investors.
- You can draw a salary that is separate from the business’ income.
Cons
- Corporations are more complicated to establish than other structures.
- Corporations are subject to double taxation, which means that you will be taxed at both the corporate and personal levels.
- More paperwork is required to run a corporation since they are more regulated by local, state, and federal agencies than the other corporate structures.
Limited Liability Company (LLC)
LLCs are best described as a private company such as a sole proprietorship or partnership with the limited liability and tax benefits that corporations enjoy. The tricky part of LLCs is that they are regulated by your specific state policy, so be sure to stay aware of these. For example, one state may require an LLC to have one or more members, while another will require 2 or more. Some states will also require an LLC to dissolve should a member leave the business, while others treat it as its own entity (like a corporation).
Pros
- You will not be held personally liable for any debts or legal actions claimed against you.
- You can choose whether you will be taxed as a sole proprietorship, partnership, or corporation through the elections made by the LLC.
- An LLC has smaller startup costs and paperwork involved than a corporation.
Cons
- Many states have a capital value tax on LLCs.
· Since the laws vary from state to state, it can be difficult to make sure that an LLC is complying with all the necessary laws and regulations. - Depending on the tax elections made by the LLC, the entire net income can be subject to self- employment taxes and must pay Medicare and Social Security.
