Choose a Business Structure

The next step in the process of starting your own business is to choose a business structure, also known as a legal structure, for your new company.  Of all the choices you make when starting a business, one of the most critical is the type of legal structure you select for your company, which will directly affect how much you’ll have to pay in taxes, and the amount of personal liability you’ll be faced with.  The type of business structure that you select will also affect your ability to raise capital, establish business credit and borrow money.

If you’re unsure about the different options available, we have outlined the different types of business ownership structure below, highlighting the advantages and disadvantages of each.  You also might consider consulting an attorney or an accountant for guidance in selecting the right form of business structure best suited for your particular circumstances.

Keep in mind, the form of ownership structure that you select will have important long-term implications affecting a wide range of critical business considerations so you need to weigh the decision about a business structure carefully.

Here are some points and issues to take into consideration when deciding on a legal structure for your business:

1. What do you anticipate will be the scope, size, and nature of the business?
2. How much control do you want over your business?
3. Will the business be vulnerable to lawsuits?
4. How much business structure are you willing to tolerate?
5. What are some of the tax implications that will be impacted by the type of structure you select?
6. Are you planning on reinvesting the profits back into the business?
7. Will you need to access profits or income for yourself on an ongoing basis?

While our preferred provider is Legal Zoom, there are several other additional services that we also recommend for business formation:

• BizFilings.com
• Corporate.com
• ActiveFilings.com

Once your business is formed, you can start building business credit through dandb.com. At the very least you’ll want to get a free DUNS number, which is required on many business credit applications.

5 Types of Business Ownership Structure

There are essentially 5 different types of business ownership structure to choose from:

• Sole Proprietorships
• C – Corporation
• Subchapter S Corporation
• Limited Liability Company (LLC)
• General Partnership

Here is a chart of the various advantages and disadvantages of each different business structure:

	C Corporation	Subchapter S Corporation	Limited Liability Company	General Partnership	Sole Proprietor
Limited liability for debts and obligations of business incurred by ownership	X	X	X	-	-
Filing at state-level registration that ordinarily protects the company name	X	X	X	-	-
Business entity can operate in perpetuity	X	X	X	-	-
Unlimited number of owners allowed	X	-	X	X	-
U.S. citizenship or residency NOT required for ownership	X	-	X	X	X
Ownership by other businesses allowed, rather than just individuals	X	-	X	-	-
May issue stock to outside investors	X	X	-	-	-
Ownership can report profits or losses on personal tax returns	-	X	X	X	X
Profits and losses for the business can be split to incur lower overall tax rates	X	-	-	-	-
Distribution of special allocations is allowable under certain guidelines	-	-	X	X	-
Annual meetings and recording of meeting minutes not required	-	-	X	X	X

Sole Proprietorships

Most small businesses when they are first formed start out as sole proprietorships. Typically, these are businesses owned by one individual who is solely and entirely responsible for running the day-to-day operation of the business. Sole proprietors maintain full ownership of the business and typically own all of the assets and profits, but also assume complete and total responsibility for any liabilities and debts that the business may incur.

Advantages of Sole Proprietorships:

• Least expensive and easiest to form business structure
• 100% control and ownership
• Profits flow directly to personal tax return of the owner
• Easiest business form to quickly dissolve

Disadvantages of Sole Proprietorships:

• Sole proprietorships have unlimited liability risk and are solely responsible for any and all debt obligations incurred by the business.
• Both business AND personal assets are potentially at risk for creditors seeking repayment of debt obligations.
• Raising capital can be difficult and often requires the owner to utilize personal savings or consumer loans that are personally guaranteed.
• Recruiting and hiring capable employees to sole proprietorships is often difficult.
• Certain employee benefits are only partially deductible from business income.

Partnerships

A partnership is simply a shared ownership agreement among 2 or more partners of a single business enterprise. This type of ownership structure will require a “partnership agreement” that addresses the following issues:

1. How will partnership decisions be made?
2. How will be profits be divided among owners of the partnership?
3. How will disputes be addressed and resolved?
4. How will new partners be admitted to the partnership?
5. How will partner “buy outs” be executed?
6. How will the partnership be dissolved if necessary?

Advantages of Parternships:

• Very easy to establish
• Ability to raise capital is increased with multiple owners
• Profits flow directly to the personal tax returns of each partner
• Prospect of becoming a partner can be an attractive incentive for potential employees
• Complimentary skills of individual partners can greatly benefit overall business

Disadvantages of Partnerships:

• All partners are both individually as well as jointly liable for actions of all the other partners
• Profits have to be shared
• Disagreements amongst partners with shared decision making responsibilities is common
• Certain employee benefits are not deductible from income
• Partnership can dissolve upon death or withdrawal of any of the partners

Corporations

A corporation is considered a unique legal entity that is completely separate and apart from its owners. A corporation has a life of its own and, unlike a partnership, will not dissolve when changing ownership. A corporation can incur tax, be sued, and enter into contractual obligations completely of its own accord. Shareholders are the owners of a corporation who elect a board of directors to oversee all corporate policy decisions.

Advantages of a Corporation:

• Limited liability for shareholders for debts, obligations or judgments levied against the corporation
• Can raise funds through the sale of stock
• Cost of benefits to employees is deductible
• A corporation continues to exist after any of its owners should die or were to sell their interest in the business

Disdvantages of a Corporation:

• Incorporation is more costly and requires more time to establish than other forms of business
• Monitored by federal, state and local agencies that, in some instances, may require additional regulatory compliance and paperwork
• Double taxation:  Income in the form of dividends that are paid out to shareholders are not deductible from income, resulting in taxation at both the corporate and individual levels

Subchapter S Corporations

A Subchapter S corporation is a type of corporation which gives a company the ability to enjoy the privileges and benefits of incorporation while being taxed as if the entity were a partnership instead.  An S corporation does not technically pay any income tax – the profits or losses are “passed through” to and divided among shareholders who then report the income or loss on their individual income tax returns.   In addition to the partnership taxation benefits, another primary benefit of this type of corporation is that shareholders have limited liability protection from creditors.

Advantages of an S-Corporation:

• S-corporations avoid the double taxation that C-corporations incur
• Distributing profits to shareholders-employees rather than salary provides additional tax advantages
• Limited liability of shareholders and directors from the debt obligations of the company
• Can issue stock to employees and outside investors
• Enjoys all of the benefits of a C-corporation but with better tax advantages

Disadvantages of an S-Corporation:

• Shareholders must be U.S. citizens or residents
• Cannot have more than 75 shareholders at any one time
• Profits or losses must be divided in a manner directly proportional to ownership interests
• Fringe benefits are not deductible for employee-shareholders owning more than 2 percent of the corporation

Limited Liability Company (LLC)

A limited liability company or LLC, as it is sometimes referred to, is a relatively new type of business structure that combines the limited liability features of a traditional corporation with the tax and operational benefits of a partnership. Forming an LLC is a bit more complex than a partnership formation, but the benefits are typically well worth the investment in time and money for those who choose this type of business structure. An LLC is not a partnership or a corporation and its owners are referred to as members, not as partners or shareholders.

Advantages of a Limited Liability Company:

• Liability protection of a corporation:  Similar to a corporation, an LLC exists as a separate entity and LLC members cannot be held personally liable for the business debts or loan obligations unless they have signed a personal guarantee.
• LLC’s have much more flexibility in their profit distribution than partnerships.
• All business profits, expenses and losses “flow through” an LLC to its individual members, avoiding the double taxation that corporations typically encounter on income.

Disadvantages of a Limited Liability Company:

• An LLC has a limited life; a corporation lives on in perpetuity but an LLC dissolves should a member die or the company go bankrupt.
• Owners who are considering the possibility of taking their company public will have fewer options to raise capital, as an LLC cannot issue employee shares or stock compared to a C-corporation or an S-corporation
• Forming an LLC is a bit more complex and formal than that of a general partnership or corporation and requires some additional paperwork.

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Tagged as: C-corporation, partnerships, sole proprietorships