Choosing a legal structure for your company is a fundamental step when starting up a new business, as it determines how it will be run, how it will be taxed, and the extent of liability its owners will be subject to. As such, it is important to understand the various types of entities available, before deciding which one suits your company’s unique needs. This article will provide an overview of the most commonly used legal structures for businesses, including the limited liability company (LLC), and the factors to consider when selecting a structure for your business.
Types of Business Structures
The most common business structures are sole proprietorship, partnerships, LLCs and corporations. A sole proprietorship is the simplest business structure, where the owner is personally liable for all of the debts and liabilities, and can enjoy all of the profits. This structure also provides the simplest taxation method, with the owner submitting business income through their personal tax return. A partnership is similar but instead of one, there are two or more owners all held jointly responsible for the debts, but are able to share the profits.
LLCs, on the other hand, provide the liability protection of a corporation, with the pass-through taxation of a sole proprietorship. An LLC is flexible and often used by entrepreneurs and small business owners, as it does not require a board of directors, troublesome management structure, and most of all allows for greater investment opportunities for the business. Furthermore, with an LLC, the management and ownership of the company can be kept distinct from each other, offering wide-ranging advantages such as safeguarding management from lawsuits.
The corporation is the most complex business structure and is used mainly by large companies that need to raise capital and list on public stock exchanges. A corporation is different from the other structures in that it is considered to be a separate and distinct legal entity, meaning that the losses and profits are reported under the company’s name, not the owners’. Additionally, a corporation offers greater liability protection for its owners, who are not personally held responsible if the business is sued or defaults on debts.
Pros and Cons of Each Business Structure
Sole proprietorship has the advantage of being the simplest structure, with few formalities needed, and it’s also the most affordable option. Moreover, since the owner is personally responsible for all debts and liabilities, it provides greater control and more freedom to run the business as they please. On the other hand, being personally liable means the owner is subject to unlimited liability.
Partnerships share the same advantages of sole proprietorship, but the two or more owners are jointly liable, meaning that each partner shares the burden of any debts or liabilities. Furthermore, depending on how the partnership is structured, the partners may even be held responsible for the actions of their fellow partners. On a positive note, the partnership provides a lower taxation rate than the individual owners, making it a more tax-efficient choice.
LLCs provide a greater liability protection to owners, limiting their personal liability, as well as providing more flexibility in terms of taxation, management and ownership. Moreover, most states do not require LLCs to prepare corporate accounts which reduces the cost and time involved. However, the costs to properly set up the LLC and ensure corporate compliance may outweigh any associated tax benefits.
Corporations are the most complex business structure, with the associated costs to incorporate being much higher than for other structures. They also require more formalities, such as meetings, resolutions and shareholder agreements, as well as more complex financial and governance documents. Furthermore, owners are subject to double taxation and rigidity of ownership rights. Nonetheless, corporations are the most popular choice for companies seeking to raise capital and list on public stock exchanges.
Considerations when Choosing a Legal Structure
When selecting the legal structure of your company, there are several factors to take into account, such as liability protection, tax considerations, business ownership, formal registration, corporate compliance and investment opportunities. It is important to speak to a qualified legal and tax professional to advise you on the most suitable structure for your particular business, depending on the size, scope and growth potential.
You should also consider the ownership rights of the business, management structure and the incorporation process. This is especially important when a company is made up of multiple shareholders or members, as the management structure and ownership share will need to be formalized through relevant documentation. This information should also be taken into account when deciding which structure best suits your business.
Finally, it is important to take into account the long-term goals of the business, as selecting the wrong legal structure could make the difference between success or failure. Therefore, it is essential to consider all the relevant factors and make the right decision for your company.