How to Choose the Best Structure For Your New Business
One of the first decisions you must make is what type of entity to create.
You’ve decided to take the plunge and become your own boss. One of the first decisions you must make is what type of entity to create. It’s important to research which option is best, because it is difficult to change your business structure down the pipeline. The primary considerations when choosing a business type include: who makes up the corporation, how you will be taxed, and where the liability for the business will lie. The options include sole proprietorship, partnerships, limited liability companies, and corporations. There are pros and cons to each option, but there is one that is just right for your new business.
- What is it? A sole proprietorship is an unincorporated business operated by an individual with autonomous control over the business. The income of the business is the income of the individual. While you do not need to register your business, you may need to file locally for certain permits or licenses, or register a “dba” trade name for your business.
- Pros: Sole proprietorship is the simplest and most common business entity. If you conduct business and have not created one of the other entities below, you are a sole proprietor. Taxes are simple because the business and individual are considered the same and only the individual’s taxes are filed.
- Cons: You are individually responsible for the business’ financial liabilities, and your personal assets are not protected from business creditors or lawsuits. Additionally, it may be difficult to raise funding or take out loans as a sole proprietor.
- Who it’s good for: Individuals with low-risk endeavors. Freelancers, consultants, service professionals.
- What is it? Partnerships are the most basic business arrangement for more than one owner, and are similar to sole proprietorships. A general partnership is comprised of multiple owners who are active in the operations of the business, and share equally in its profits and losses.
- Pros: It can be helpful to have partners when starting a new business. Profits and losses are passed through directly from the business to the partners, split among the parties. The business is not taxed, only the individual business partners are.
- Cons: Partner disputes or negligent actions can derail a business, so having a good partner agreement is crucial as all partners share responsibility. As with sole proprietorships, the business’ liabilities become the owners’ personal liability.
- Who it’s good for: Professional groups, such as attorneys.
- What is it? Limited partnerships are similar to general partnerships, except only one of the partners assumes most of the liability as the general partner, and the remaining (limited) partners have limited liability and control. Only the general partner pays self-employment taxes.
- Pros: The general partner can maintain control of the business while taking on investors as limited partners. The limited partners assume no personal liability and may leave the business without dissolving the entity.
- Cons: The general partner assumes personal liability for the business’ liabilities. A limited partnership requires filing the business entity with the state and is more expensive to create than a general partnership.
- Who it’s good for: Businesses with investors.
Limited Liability Entities
Limited Liability Company (LLC)
- What is it? A registered business that protects the owners from the debts and liabilities of the company.
- Pros: Business owners’ personal assets are protected without the formalities and filings of a corporation.
- Cons: An LLC costs more to establish than a sole proprietorship or partnership. LLCs may have a limited life-span; if ownership changes, the company may have to be dissolved and re-formed.
- Who it’s good for: Small business owners and freelancers, especially those with significant personal assets.
Limited Liability Partnership (LLP)
- What is it? A registered business partnership where no individual is personally liable for the business.
- Pros: All owners are protected from shouldering the business’ debts, as well as from the negligent actions of the other partners, such as malpractice.
- Cons: A limited liability partnership requires filing the business entity with the state and is more expensive to create than a general partnership.
- Who it’s good for: Licensed professional groups, such as attorneys, accountants, or architects.
Corporation (C Corp)
- What is it? A corporation, or C corp, is a business created as an entirely separate entity from its owners, who are shielded from the liabilities of the business. Corporations are taxed and can make a profit, and are held legally liable.
- Pros: Owners’ personal assets are protected. Corporations can sell stock to shareholders to raise-funds. Shareholders can sell their stock and leave the business without affecting its operations.
- Cons: Corporations have more stringent record-keeping, operational, and reporting requirements. Profits may be taxed twice, once as a corporation and again on personal tax returns when the shareholders receive their dividends.
- Who it’s good for: Medium- or high-risk businesses; businesses wanting to raise capital, go public, or be sold.
S Corporation (S Corp)
- What is it? An S corporation is a special type of corporation with specific requirements that allows profits to be passed-through to shareholders without paying corporate taxes.
- Pros: S corps eliminate the double-taxation of a C corp; S corp taxes are similar to a sole-proprietorship or partnership.
- Cons: There are certain restrictions on what type of entities can file as S corps (fewer than 100 shareholders, all must be U.S. citizens, etc.). Creating an S corp requires filing with the IRS as well as the state, in addition to the same stringent record-keeping, operational, and reporting requirements as C corps.
- Who it’s good for: Businesses that would be a C corp but qualify to receive the tax benefits of a pass-through entity.
Benefit Corporation (B Corp)
- What is it? A benefit corporation, or B corp, is a special type of for-profit corporation that exists to benefit the public in some way. It operates as a C corp for taxation purposes, with additional transparency and accountability.
- Pros: Becoming certified as a B corp raises public awareness of your company’s social responsibility.
- Cons: Not all states recognize the B corp status. While third-party organizations exist for certification, it is not required to utilize them in states that recognize the B corp legal status.
- Who it’s good for: Businesses with a social or environmental mission who wish to attract like-minded investors and employees.
We recommend consulting with an attorney and accountant before forming your business. They can help advise which type of entity is best for your new business and guide you in the process of starting up. Remember that ownership rules, liability, taxes, and filing requirements for each business structure can vary by state.
Good luck on your new business!
Category: Freelancer Tips
Updated: December 12, 2019
Quick note: This is not to be taken as tax advice or legal advice. Since tax rules and laws change over time and can vary by location and industry, consult a CPA / tax advisor and/or attorney for specific guidance.