Among the many other things that a business owner has to consider when starting a business, one of the most important things, if not the most important thing, that a business owner has to consider, is what legal structure is best for the business. In the beginning, there are many factors to consider.
The most common legal structures for a business are: (1) Sole Proprietorship; (2) Partnership; (3) Limited Liability Company; and (4) Corporation. When a business owner is starting out and deciding which structure will work best for the business, some of the most important factors to consider are: (1) flexibility; (2) liability; (3) complexity; (4) taxes; (5) control; and (6) whether the business will require, desire or need funding. All of these factors are important to determine which structure is appropriate and each state has its own regulations for each type of business.
Each legal structure has benefits and which structure is appropriate will depend on your specific set of circumstances. We will briefly examine a few here. The sole proprietorship, for example, is great for an individual business owner starting out on their own. It’s easy to set up with very little paperwork to file. The costs vary by state, but are typically very low. The tax structure is simple and there are certain deductions that you may be eligible for. We always recommend that our clients work with their accountant before they decide which structure is best because it’s important to know what the income tax implications are of the structure that you choose. For an individual, though, a sole proprietorship is a great place to start.
A partnership is a business that is owned by two or more individuals. A partnership is a great place to start when you want to go into business with another person, such as a family member, friend, or colleague. There are two kinds of partnerships: a general partnership and a limited partnership. A partnership allows people to share in the profits and losses, as well as the decisions (both good and bad) that are made on behalf of the business. The costs can be higher when you start a partnership because, as we always emphasize, it is so important to have a written partnership agreement, which should be, at a minimum, reviewed by an attorney.
A limited liability company is a structure that has what are called members, and allows them to limit their personal liability. This structure also provides business owners with the protection of a corporation while allowing them to pass earnings and losses through on their personal income tax return. Profits and losses do not have to be divided equally among members. The costs, however, are higher than a sole proprietorship and partnership. They vary by state, but include a filing fee with the state and, at least in New York, there is a publication fee. We also recommend that when you form a LLC, you have an attorney prepare an operating agreement which will outline the details of the business and the relationships between the members.
A corporation is an entity that is separate from its owners and has its own existence. Ownership is in the form of shares, and it is operated by a Board of Directors. There are different kinds of corporations, which are more appropriate, in our opinion, for businesses that are a little further along in their existence. Shareholders are protected from personal liability and there are certain tax advantages to forming a corporation. A corporation is also beneficial because it allows you to raise capital, for example, through shareholders, if that is what your business needs. Similar to the LLC, a corporation has certain filing fees associated with it, and it is important to have an attorney prepare the written agreements that are appropriate for a corporation, such as a shareholders agreement.
Before you decide which structure is appropriate for your business, it is important to sit down and write out what your business plan is, what your goals are, and what your vision is for the company. What factors are most important to you – is it flexibility? Tax benefits? Protection from personal liability? Once you know the answers to these questions, and you consult with an attorney AND an accountant, you can make the best decision as to what structure is the most appropriate for your business.
