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Structuring Your Business Entity
When you start a new business, you’ll have to decide upon the type of business entity to want to use. There are a number of options available to you, and each has its advantages and disadvantages. There’s simply no one-size-fits-all answer as to what type of entity is the “best”. You need to take stock of your particular situation, and decide what’s best for you and your business.
The most common types of entities are:
• Sole Proprietorship – This is the simplest form of business organization, where the business effectively operates as an extension of the owner.
• General Partnership – This is a relatively simple way for two or more partners to own and control the operations of the business.
• Limited Partnership – This form of business organization is similar to a General Partnership, except that all but one of the partners can limit their personal liabilities if something goes wrong in the business.
• Limited Liability Company – This form of business entity provides limited liability to all of its members, and the members have more flexibility (compared to general partnerships and limited partnerships) in how they want to allocate the profits and losses of the business.
• Corporation – This well-known entity is a common way for businesses to organize themselves. The corporation is considered to be a separate legal “person” under the law, so it is taxed on all corporate income. Any amounts paid to shareholders as dividends are also taxed to those shareholders.
The summary above is very much simplified, so you should do more research on each of these types of entity, and the suitability of each for your business. In doing so, here are several key things you should consider:
How soon do you plan to start your business? It is generally very easy to organize your business as a sole proprietorship, and you will spend less time preparing and filing paperwork than with the other types of business entities. Forming a corporation can be noticeably more difficult than forming the other types of entities.
Thankfully, most states have made the formation process much easier for all types of business entities, by permitting applicants to file their initial paperwork and yearly reports online.
Will you own the business yourself, or with other? Certain business structures more easily accommodate more than a single owner, and limited liability companies are very flexible in their ownership structures. Different types of corporations (such the “subchapter S” corporation, which is similar to a limited liability company in tax treatment) have limitations on the number and type of permissible owners (such as that the owners must be individual persons, not other corporations).
Also keep in mind when you are preparing your organizational documents that you should consider what you want to happen if one of the owners wants to leave the business. It may be uncomfortable (and seem unnecessary) to think about this at the beginning of the business, but it can save a lot of stress and expense if these issues are worked out beforehand.
How do you intend to finance the growth of your business – do you anticipate seeking outside investment? If so, what kinds of investors will you target? Different types of business entities are better suited to different types of investors.
For example, limited liability companies can easily be structured to accommodate many different types of investors. Not surprisingly, corporations are often the investment vehicle of choice for large and institutional investors.
In general, the simpler legal structures are less expensive to form, and require less money to maintain. For example, depending on its capital structure, a corporation formed under the laws of Delaware could be required to pay tens or even hundreds of thousands of dollars a year in so-called franchise taxes. These extreme situations apply to corporations that are extremely large, but they illustrate how you need to factor these considerations into your business planning.
You may also wish to consider the various recordkeeping requirements that are applicable to each type of business entity. You’ll need proper accounting records regardless of the type of your business entity, but the additional legal recordkeeping requirements can vary. For example, corporations have relatively stringent recordkeeping rules (compared to other entity types), and also have shareholder and annual meeting requirements.
Depending on the nature of your business, you may need to give liability issues extra consideration. If you’ll have employees making deliveries or otherwise driving on company business, then it’s not hard to imagine a traffic accident occurring, and this could expose your business to lawsuits.
A sole proprietorship does not protect the personal assets of the owner. This means that if there is a successful lawsuit against your business, the suing party can use your personal assets (like your car, your savings account, and your house) to satisfy their claim. The general partners of a general partnership have similar exposure.
The limited partners of a limited partnership, the members of a limited liability company and the shareholders of a corporation are all generally insulated from personal liability. However, certain legal formalities must be observed, otherwise a court can “pierce the veil” of the legal entity and disregard the liability protections that would otherwise apply.
Different states have different tax laws and requirements, so you should consult your tax or accounting advisor to learn more about exactly what to expect in your state. In general, in a sole proprietorship the profits and losses of the businesses will pass through to the owner’s individual tax return. This avoids the additional layer of taxation that occurs at the corporation level. Similarly, the limited liability company structure does not incur taxation at the company level; the tax on income occurs at the level of the individual members occurs only on income that is distributed to them.
These are just some of the issues that you’ll need to consider when you decide which type of business entity is the best fit for your needs. Take the time to think about what you’ll need, and you’ll likely end up saving yourself a lot more time (and money) in the long run.
About the Author
Jeremy Gislason is a leading expert on membership sites, marketing and online business. Do you need legal advice for your online business? Be sure to check out our legal advisors at: http://www.memberspeed.com/Recommended_Resources/resource/Legal/index.html
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