Starting a new business involves making critical decisions. One of them is deciding on your business structure. Also known as a business entity, a business structure is the legal representation of how your startup is organized.
The entity you choose carries legal and financial implications. It can affect how your business operates daily, the taxes you pay, and the degree of risk or liability on your personal assets. Hence, it’s crucial to structure your new business appropriately from the outset.
You can change to a different structure down the line. However, it may come with restrictions and hefty costs. Consulting an attorney or accountant can help you make a well-informed choice.
This article explores the different types of business structures to assist you in the decision-making process. We also examine vital factors when deciding on your startup’s legal structure.
The level of uncertainty and risk in startups is likely higher since they’re in the early stages of business. Considering this, the wrong choice of business structure can have substantial repercussions.
Before deciding on what entity is most appropriate for your new business, gaining a basic understanding of each legal structure is imperative. The following are business structure options entrepreneurs commonly choose when launching a new venture:
This business structure is the easiest and most inexpensive to set up, as it requires minimal paperwork. You have complete ownership and control over the business and can retain all earnings. However, it also means you’re personally liable for all debts, taxes, and lawsuits the startup accrues.
A partnership works similarly to a sole proprietorship. The main difference is that a partnership business structure has two or more owners. Raising capital is also much easier with multiple partners running the business. But like a sole proprietorship, this business entity has unlimited liability. It means the owner’s personal assets will bear the consequences if the startup fails.
This type of business entity is more complex and expensive, so it’s a common choice among large organizations. However, many entrepreneurs start corporations because of their limited liability protection. Under this business structure, owners and shareholders are personally and legally responsible for the company’s debts and liabilities, but only up to the amount of their investment.
Limited liability companies (LLCs) are a newer form of business structure. It’s an attractive option for small and large companies because of its flexibility and tax advantages. Like corporations, an LLC keeps you from being personally liable for the startup’s financial liabilities and legal issues.
As you know, you can structure your business venture in various ways. But how do you select the right one for your startup?
The best choice depends mainly on your business goals and circumstances. Take the following factors into consideration when choosing your startup’s legal structure:
What type of liability protection do you need? If you have significant personal assets, you may opt for a business structure that protects them.
A sole proprietorship or partnership may not be the best choice in terms of asset protection. These business entities carry a high level of personal liability since there’s no legal separation between your startup’s assets and what you own.
How much compliance complexity can you manage? Each business’s legal structure has different compliance requirements.
If you choose a corporate structure, you must submit articles of incorporation and annual reports. Special paperwork may also be required for partnerships. A sole proprietorship can be a great option if you want relatively few compliance requirements, but it puts your personal assets at risk.
The advantages of limited liability protection outweigh the disadvantages of complicated compliance requirements. Alternatively, an LLC may also be worth a look if you want a balance between administrative complexity and liability protection.
The LLC structure has fewer complexities in terms of formation and compliance requirements. It also protects your personal assets, as it considers you a separate entity from your startup.
How do you prefer to pay taxes? Your choice of business structure can significantly impact your tax burden. When selecting a business entity, you may want a structure that gives you flexibility in your tax planning and lowers the tax you must pay.
Pass-through taxation is appealing to many small businesses. With a pass-through tax, the company is taxed at the individual level. Tax preparation is easier as you only file your personal income tax forms.
The drawback of pass-through taxation, however, is you may miss out on the tax advantages available to other businesses since your startup is not taxed separately. Sole proprietorships, partnerships, and LLCs are considered pass-through business entities.
Conversely, some businesses prefer the corporate structure’s double taxation to reduce their tax burdens. In this case, the company must file taxes separately from the owners or shareholders. It means the company pays corporate taxes on its profits while shareholders pay personal taxes.
Growth is a critical component of any business. When deciding on a legal structure, it’s also beneficial to consider its ability to accommodate your startup’s future needs.
Is the entity easy to exit if you plan to sell? Does it allow for easy transition and growth when you incorporate new investors? Considering these questions can help you decide whether the business structure can support your company’s growth in the future.
Structuring your startup correctly from the beginning can save you unnecessary stress and costs in the future. Suppose your business faces legal issues and financial difficulties. The right legal structure can protect you and your personal assets.
A registered agent may be required when setting up a business structure, depending on the entity you choose. You don’t need to designate one for sole proprietorships and general partnerships. However, most states require you to appoint a registered agent to set up an LLC or corporation.
Suppose you decide to protect your startup with an LLC. You can hire a registered agent and reliable formation services for a reasonable amount. For example, the combined cost of the Northwest registered agent’s $39 fee and the state fee can be considered a fair charge for LLC formation.
Moreover, seeking guidance from an experienced lawyer or accountant is always wise when choosing your startup’s legal structure. Remember that states may have varying requirements for different business structures.