How to decide which business structure is right for you

March 26, 2014

Choosing a legal structure for your business is important. E.J. Dealy, CEO of The Company Corporation, shares tips on choosing the proper business structure.

As CEO of The Company Corporation, I have the opportunity to interact with people who are interested in starting a small business  on a daily basis.  Launching a business can be a fun and rewarding way to do what you’re passionate about on your own terms. However, it’s important that you properly plan the process to make sure it goes as seamlessly as possible.

One of the most important steps is deciding upon a legal structure that best suits your particular business and how you’re planning to grow. There are a few options to consider. Each has its pros and cons. Learning more about each is the only way to determine which one is right for you.

Sole Proprietorship & Partnerships

Sole proprietorship is the simplest structure an owner can use for his or her business.  It’s run by only one individual who pays personal income tax on any profits from the business. There is minimal government regulation, so it is the quickest structure to set up and end.

The main disadvantages of this structure are that the owner is responsible for the company liabilities and raising capital. Financiers may be hesitant to support or make loans to sole proprietorships.

One can also form a partnership. There are two types of partnerships that new business owners can form.

General Partnership: Within this structure, all partners each share equal limited liability for any debts and profits of the business. In a general partnership, each partner also typically participates in day to day management of the company.

Limited Partnership: The difference with a limited partnership is that, along with one or more general partners, there are also limited partners. Limited partners don’t participate in the course of the business but still contribute capital. Limited Partners are also only personally liable for how much they contribute.

C-corporation

The C-corporation is the most general structure to choose from. Owners will have limited liability protection and can share profits with the corporation to lower the tax rate. This structure can also go public to sell shares over a public trade; any LLC, sole proprietorship, or partnership that wants to go public must change to a corporation in order to do so.

Those with a C-corporation are owned by shareholders, have less chance of being audited and a potentially unlimited number of stockholders. The main drawback of the C-corporation is that income is taxed at the corporation level and at the individual level when circulated back to the owners.

S-corporation

This structure is similar to a C-corporation but isn’t taxed at a corporate level. However, there is also a limited amount of potential shareholders (100 maximum) who all must be US citizens and residents. Also, S-corporations aren’t able to have multiple classes of stock and cannot be owned by any other type of business (C-corporations, S-corporations, LLCs, etc.).

Despite the lesser flexibility of an S-corporation verses the C-corporation, a S-corporation has the benefit of owners being able to report business profit and loss on their personal tax returns. This option is more suitable for domestic small businesses.

Limited Liability Corporation (LLC)

This business structure is often the most preferred because it combines aspects of the partnership and corporation.

What makes the LLC attractive is that everyone in the company is protected from personal liability from debts; the members involved with the company can claim any company losses on their personal tax returns. Other benefits to this structure include unlimited potential shareholders and much less paperwork than one would encounter in a more complicated corporation.

There are some disadvantages however. For example, in some states it is required to pay a franchise tax that can be based on anything from profits, the number of members and more. The other main disadvantage is how relatively new this structure is. Many aspects of the structure are often misunderstood and this can cause difficulty in attracting investors and raising funds. The long-term health of this structure also isn’t as tested as others either and future problems could arise in the as the company grows.

As you can see, there are a variety of options available to help you decide on a legal structure for your business. It’s important to consider how much you want to grow your business, how much you want to invest in your business and how much control you want before going with any of these options.

E.J. Dealy is CEO of The Company Corporation (http://www.incorporate.com), which supports entrepreneurs and small business owners in forming their business structure. The Company Corporation does not provide legal, financial or tax advice.

Note: The Company Corporation is running a 5 Tips for $5,000 giveaway (http://www.incorporate.com/five_tips_giveaway.html) for small business owners. Once you’ve finished reading this article on choosing a business structure, head over to the page and submit your tips. The giveaway ends on Tuesday 3/31. To enter, submit your name, email and company name in addition to five tips you learned from starting your small business. The Company Corporation will publish your tips and information on its website (Incorporate.com). The contest gives businesses a chance to provide insights to other members of the small business community.