Are you starting a new company and can’t decide which business structure to use? You’re not alone. Every small business owner faces this choice. It requires some thought about the type of industry you’re in and how you plan to grow and develop your business.
Things to Think About
Before you decide on a business structure, here are a few issues to think about:
- How easy is it to set up and operate?
- What are the tax advantages and disadvantages?
- What are the potential legal liabilities?
- How easy will it be to liquidate the business?
- Do you plan on raising more equity capital as the business grows?
- What are the regulations to keep the business structure active?
- How much record keeping is required?
- What happens to the business upon the death of the owner?
The easiest business structure to start off with is the sole proprietorship.
Pros and Cons of a Sole Proprietorship
A sole proprietorship is the common business structure. It makes sense if you’re in a business where personal liability is not a concern. From a legal standpoint, the owner and the proprietorship are the same.
- It’s the easiest to set up because it doesn’t require the filing of any papers.
- States do not require the registration of proprietorships.
- Profits are only taxed once on the owner’s personal tax returns.
- The owner has complete control of the business and makes all the decisions.
- Tax forms are not complicated.
- Assets are easy to liquidate upon the death of owner.
- The owner is exposed to unlimited legal liabilities. If you lose a lawsuit, you could lose your home, car and other personal assets.
- Proprietorships cannot accept capital from outside investors.
- Borrowing money is more difficult. Banks are reluctant to make business loans to sole proprietorships. You will have to rely on savings, home equity loans or loans from family members.
- Business will be liquidated when owner passes away.
But, what if your business has more than one owner? A partnership could work in this case.
Pros and Cons of Partnerships
A partnership is a sole proprietorship that allows the business to have more than one owner.
- They’re easy to form.
- A partnership can bring together a group of individuals with different talents to share in the responsibilities of running a business.
- If the partnership agreement permits, a partnership could continue to exist if one of the partners dies.
- Partners are exposed to unlimited liabilities.
- Owners will not always agree on decisions. This could lead to management conflicts.
- Partners share in the profits of the business, but will not always feel they are being adequately compensated for their contributions and services.
Are you concerned about the unlimited liability exposure that risks losing your personal assets in a lawsuit? The next step up is to form a limited liability company.
Pros and Cons of Limited Liability Companies
- The owners have limited liability. The owner’s personal assets are protected from judgments and defaults on company debts.
- Owners can choose how the business pay taxes. It could be a proprietorship, a partnership or a corporation.
- Most states don’t require LLCs to have annual meetings.
- An LLC is not required to have a board of directors.
- The number of shareholders is unlimited.
- Legal and accounting costs are higher than proprietorships.
- LLCs must file articles of incorporation with the state of domicile.
- Owners must create an operating agreement that defines management authority and limits to making decisions.
- In some cases, an LLC will cease to exist upon the death of a member, unless otherwise specified in the operating agreement.
Suppose your business is growing and you need to attract more lender and investors. A C Corporation may be necessary.
Pros and Cons of C Corporations
A corporation is a legal entity that’s completely separate from the shareholders who own stock in the company. It has the authority to enter into contracts and buy and sell property. A corporation can sue other parties but can also be sued.
- Owners do not have personal liability for debts of the corporation. A shareholder only risks the amount of the investment in the company.
- Has more access to financial resources. A corporation can sell stock to raise capital, obtain bank loans or issue bonds for long-term financing.
- Corporations are better able to attract more talented and skilled employees than proprietorships.
- The corporations continues to exist separately from the lives of its stockholders.
- A C Corp is the most complex business structure and requires a lawyer to set up.
- Earnings could be subject to double taxation.
Not thrilled with the prospect of paying taxes twice with a C Corp? An S Corp could be your solution.
Pros and Cons of S Corporations
S Corporations combine the tax benefits of proprietorships and LLCs with the liability protection of C Corps.
- Avoids double taxation by passing income through to the owners.
- The structure of an S Corp protects the personal assets of the shareholders.
- Lenders are more willing to make loans to S Corps.
- Articles of incorporation must be filed with the state.
- An S Corp is limited to 100 shareholders.
- It can only have one class of stock.
- Fringe benefits provided by the company to shareholder-employees are taxable as compensation.
The choice of which business structure to use demands thought about your type of business and what you want it to look like. If the business is just yourself, a sole proprietorship could be enough. But, if you’re worried about personal liability and risking personal assets and taxes, consider an LLC, a C Corp or an S Corp.