Starting a small business is both an exciting and stressful time. There are so many decisions to make—how to market your product, what your logo will look like, and whether to hire staff. Before you make any of these decisions, you should consider how you want to structure your business. You should only make a business entity selection after you have examined the needs of your business and how you plan to operate.
Perhaps the simplest way to structure a business is with a sole proprietorship. With a sole proprietorship, your business is not separate business entity. You can still apply to operate under a business name, the paperwork will just reflect your name doing business as (DBA) your business name. Not being a separate legal entity also affects how your personal assets are viewed. According to the U.S. Small Business Administration, any debt or legal trouble encountered with a sole proprietorship could endanger your personal property.
You may consider becoming a sole proprietor, if your business has low risk for legal issues and your revenue stream is not overly complex. It can also be a good way to try running your own business.
Running a partnership obviously requires two or more parties to form a partnership. This type of business may make sense for a business with multiple owners who is testing out the profitability of a business idea. With partnerships, you can have a limited partnership (LP) or a limited liability partnership (LLP).
With a LP, there is one partner who has unlimited liability, and the other partner or partners have limited liability. This means the other partners may be protected from business debts affecting their personal assets. However, the limited liability partners usually have less control over the company. The partner without limited liability has more control over the business, but again, is at more at risk with personal finances. This partner must also pay self-employment tax.
A LLP gives limited liability to all partners. It usually protects all parties from debts against the business, as well as debts incurred from the other partners.
Limited Liability Company (LLC)
Forming a LLC offers some of the protections of the partnership and the corporate structure. You may consider creating an LLC if your business poses a higher risk, you want to protect your personal assets, or you want to be taxed at a lower rate. Like a LLP, an LLC usually protects your personal assets from debt or lawsuits against the business. If you are an individual with an LLC, you will be taxed at the sole proprietorship rate. If there are multiple owners, you can choose to be taxed as partnership, or elect to be taxed as a corporation. A corporate tax form should lower your tax rate.
Filing to become a corporation makes sense if your business is higher risk, you need to raise money to start the business, or if your eventual goal is to become a publicly traded company. Corporations are entirely separate entities. Since the entity is separate, you and your partners should not be personal liable for any business debts. However, it costs more money to create a corporation, and the business is subject to much more oversight.
As a corporation, you must file paperwork for the articles of incorporation and create corporate by-laws. You will also need a board of directors and will issue shares of stock to divide up ownership of the company. There are laws from the Securities and Exchange Commission that direct how stock is issued. With a corporation, record-keeping, reporting, and other operational processes require much more scrutiny. Corporations must also pay income tax on profits.
The type of business you are operating, your personal assets, and whether you are starting a business with someone else affects the kind of business structure you should pursue. Each entity type has benefits and drawbacks, so you will need to honestly assess what would work best for you and your future enterprise.