If you’ve never been involved in launching or owning a business, then you’re probably unsure of what to do with your very first venture. And while there are lots of different aspects to consider, legal protection in the form of corporate structure is one of the most important elements…
Why Your Business Structure Matters
“Of all the choices you make when starting a business, one of the most important is the type of legal structure you select for your company,” Entrepreneur.com explains. “Not only will this decision have an impact on how much you pay in taxes, it will affect the amount of paperwork your business is required to do, the personal liability you face and your ability to raise money”
You don’t just happen upon a business structure or choose one because it’s convenient. You should perform intensive research and exhaustive due diligence to find the setup that’s right for you. A failure to take factors like liability, taxation, administrative costs, flexibility, and scalability into account could set you up for failure from the very start.
As you do your research, think about both the present and the future. Your hopes and goals for the first three to five years will partially dictate the direction you take. But you also need to be cognizant of 15 or 20 years down the road. Would you want to pass the business off to a child? Are you hoping to create a passive/residual stream of income one day? Taking future plans into account will prove to be even more beneficial.
Four Business Structures to Consider
There are many different types of business structures to choose from, but you’ll find some more practical and flexible than others. Here are four that fall into this category:
1. Sole Proprietorship
Let’s begin with the simplest structure of all: the sole proprietorship. Under this structure, you are the only owner and operator of the enterprise. The tax aspects of the sole proprietorship are what make it so attractive. Income and expenses can be filed on your own tax return. Profits and losses are recorded on a Schedule C, which is filed with a simple 1040. It’s a piece of cake.
There are also some potential disadvantages to consider. For example, you are personally responsible for your company’s liabilities. (If a lawsuit was filed against your business, your own house or personal assets could be seized to satisfy your debt.) You’ll also find it somewhat challenging to raise money from banks and traditional lenders, as they don’t always take sole proprietorships as seriously as other business structures.
2. Limited Liability Corporation (LLC)
If you want flexibility and some separation between the business and your personal assets, a limited liability corporation (LLC) is always a good option to consider.
As Incfile explains, LLCs are fast and cheap to establish, have a very simple business structure, face very few regulations and compliance issues, and are regulated on a state level.
One potential downside to an LLC is that it’s easy for you to accidentally “pierce the corporate veil" and put your personal assets at risk. You also face self-employment tax, which can cut down on your earnings.
If you’re looking for stronger separation between you and your business, a corporation is a great idea. While it comes with more expenses and legal hoops to jump through, a corporation allows you to maximize protection and grow with the future in mind.
“A partnership is a business entity with two or more individuals who share the risks and benefits of the business," entrepreneur Jean Murray notes. “A partnership can include general partners who bear liability for partnership debts and for actions of the partnership. It might also include limited partners who are merely investors and who don’t share in the day-to-day operations of the business or in liability."
The types of partnerships available to you will depend on the regulations in your specific state. You’ll also have to stay on top of paperwork from year to year, which can be annoying to some.
Take Your Time
Don’t rush the process. You don’t have to choose a business structure overnight. Research will be rewarded with results. Examine the pros and cons of each corporate structure and make a decision that you believe is best for both the short-term and long-term. While there is no perfect answer, there should be at least one structure that meets your needs and goals.