One of the first, and most important, decisions a startup entrepreneur needs to make is to decide the business’ structure entity. How will he decide to legally structure his new company for tax, ownership and financial purposes? There are many choices, such as Corporations of different types, partnerships, LLC limited liability and DBA, doing business as, a sole proprietorship. This article will guide you through both the decision-making process and the steps to set up our chosen business entity.
In the United States, these are the most commonly used business legal structures, listed in order of simplicity to complexity:
The easiest way to begin any business is as a sole proprietor. You are acting as the business, and all the income and expenses are reported on your personal income tax. This entity is the lowest cost of any business structure since most states only require a completed form and nominal fee. In the early stages of business, losses can offset tax liabilities from other income sources such as old-time employment. But don’t be fooled into thinking that this structure is without risk. In fact, it is the riskiest of all business structures, because you will be responsible for all of the firm’s liabilities and lawsuits.
Recommended for businesses with fewer employees, solopreneurs, consultants who have adequate insurance and few financial assets that need protection.
Partnerships can be either general or limited. In general partnerships, both parties are responsible for the businesses debts. While a limited partnership weights the personal liability of general partners while also having limited partners whose liability matches the amount they have invested in the firm. Regular reporting of profits and losses and a separate tax return are filed with the partner’s personal tax return. These type of structures are moderately priced to set up and also allow any business losses to be applied to the partner’s tax bill. The biggest problem with most partnerships is the partners. Since you are both responsible for the company, if your partner bankrupts the firm, you will be left holding the bill.
Recommended for businesses owned by several people, notably used in the real estate industry.
A corporation is like a separate business from the owners of individual shares. Because of this separation, it protects the partners from personal liability in lawsuits and bankruptcy. There are many types of corporations, and the S-corporation is the most commonly used type for small businesses. For larger startups, the C-corporation may be used instead. Corporations have shares, like small pieces of the company, owned by outsiders investors. As such, businesses who choose the corporation structure will have a Board of Directors and shareholders that they will need to report to regularly and get their approval for major purchases. This business structure is more expensive and much more complex than either the sole proprietorship or partnership. Additionally, you will need to hire a trained accountant or tax preparation sure you are following the many rules.
Recommended for businesses that need liability protection and the ability to grow into a major firm. Many manufacturers and restaurants use this legal structure.
Not all businesses should incorporate. While there are many advantages of incorporations such as protections of your personal financial assets, privacy for you and your family, raise working capital from investors shareholders and build credit score for your firm it is not for all businesses.
- Startup firms that intend to seek venture capital must be incorporated to be both considered seriously and for transactional ownership distribution.
- Companies with more than one employee, since your liability is substantially increased when somebody else acts on your behalf.
- Firms that work off premises and could damage other people’s property during the course of business – such as contractors and repair firms.
- Companies who deliver, by car or plane, goods and services since damage from accidents could become the business owners responsibility.
- Manufacturing of consumer products will not be able to purchase liability insurance without being incorporated.
Small, one-person companies, solopreneur firms that are well-insured and have little financial assets, do not deal in products and services that could are not prone to liability issues (such as consumer goods) and those company who do not have the budget to incorporate at the onset.
If you have decided that a corporation is the best legal business structure for your startup, let’s now select the right type of corporation you want to set up.
- Uses venture capital funding
- Profit sharing amongst owners with flexibility
- Retain earnings in business to fuel growth
- Ability to divide earnings between corporation and shareholders to reduce taxes
- Salaries for owners to reduce taxes in Social Security and Medicare specifically
- Corporate benefit programs to include extended fringe programs such as transportation budgets, life insurance policies and education reimbursements.
- The business is packaged ready for sale in the future
- Employee stock option programs
- Own real estate in the corporation
- Need for reduced IRS audit possibility
- Want use pass-through taxation advantage to the business owners personal tax bill
- Accounting method versatility preferred, not being dictated to use the accrual method of bookkeeping, if not holding inventory.