Deciding on your new organization’s legal structure is one of the most important decisions you’ll ever make. Because the legal structure of your business entity will affect some of the most critical aspects of your organization, you need to make the right choice.
The business structure you choose now will affect your legal liability, tax payments, and how much control you have over your business for years to come.
The various legal structures – partnerships, limited liability companies (LLC), sole proprietorships, and corporations – have different sets of rules and offer different benefits.
Here are six of the most important factors you need to consider when deciding on your company’s legal structure. Remember, the legal entity you choose now can impact the future of your business in unforeseen ways!
1. Separating Management and Ownership
One massive concern for any business owner is personal liability. Three legal business structures offer protection for the owner when it comes to lawsuits brought against the business. If being vulnerable to personal liability concerns you, you should look into how to start an LLC, limited partnership, or corporation.
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On the other hand, general partnerships and sole proprietorships dictate that the organization’s owner can become personally liable for their management and business decisions – this is because they do not separate the management and ownership of the business.
2. Limited Liability Protection
If you do not want to be held personally liable for any lawsuits brought against your business, you probably want to extend the same liability protection to your assets as well.
Limited liability protection is often the sole deciding factor when entrepreneurs choose their company’s legal structure. For this reason, business owners often decide to start C corporations, S corporations, and LLCs.
Once again, general partnerships and sole proprietorships do not offer protection for the business owner’s assets because they do not separate management and ownership of an organization.
3. Tax Treatment
A major complaint made by many business owners is having to comply with double taxation. The laws that govern C corporations mean that the organization’s revenue is subject to tax from the state and federal government as well as to any personal income the business owner brings in from the organization.
To avoid double taxation, consider starting an LLC or an S corporation. LLCs and S corporations are subject to pass-through taxation – which means that taxes are not imposed on the business and the business owner. Instead, taxation falls on the income the business owners and investors receive from the LLC or S corporation.
However, there is a downside to these business entities. LLCs are taxed like sole proprietors or partnerships and subject to self-employment taxation based on what they earn as a salary. S corporations are subject to self-employment taxes for the entire profit the business generates.
4. Transferring Ownership
When it comes to C corporations and S corporations, the transferral of ownership is relatively straightforward – the owner simply sells their stock to a new owner.
On the other hand, transferring business ownership with other business structures is not as simple. Owners of sole proprietorships are legally required to sell the entire organization to transfer their ownership, and partnerships must be dissolved.
5. The Ability to Raise Capital
How you raise capital – something that’s vital for any business – is highly regulated depending on the organization’s legal structure.
Regulations pertaining to raising capital are the most flexible for C corporations, and raising capital for a partnership is subject to rigid regulations. S corporations are somewhere in the middle – with some of the flexibility of a C corporation, but its shareholders may not exceed 100.
6. Ease of Formation
Now that you understand the pros and cons of different business structures, you’re probably wondering why anyone ever starts a partnership or sole proprietorship rather than an LLC or corporation that offers greater personal liability protection. Well, the answer is simple – it’s the entities’ ease of formation.
Sole proprietorships are the least complex to set up – only requiring the business to be registered with the appropriate agency in your city, county, and state.
Every other legal entity needs to be registered with the local Secretary of State and adhere to and maintain recordkeeping rules that document which limited liability clauses are in place.
Making sure the organization remains in good standing and maintaining the appropriate records can be time-consuming and costly. Something to bear in mind, though – the limited liability protections some legal structures afford may be priceless.