While small businesses across the U.S. struggle to stay afloat during the pandemic, countless others are just beginning or plan to start after the new year. In celebration of National Entrepreneurship Month, the Everyday Law blog will be serving up lots of useful information every Monday to help you with everything from choosing a business name to protecting your personal assets to picking a business entity, which is what we’ll be discussing today. While not the most glamorous of business tasks, choosing the right legal structure can sometimes mean the difference between a thriving business and one that has to shut its doors after just a year or two. So let’s get started!
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How do I choose the right business structure?
The “right” company structure for you may not be the same as for other businesses. What works for the flooring business down the street may not work for the consulting service you are creating.
Information is power—and doing your research when it comes to business entities will help you make an informed and accurate decision that is tailored to what you and your company need to thrive for years to come.
Below are just a few questions that you should consider as you start this process.
- How many people will be involved in the ownership?
- How do I want to attract investors? Do I need to attract investors?
- Will the business own substantial assets?
- Is a physical location necessary?
- What kind of clients do you want to attract? Are those clients expecting an “Inc.” at the end of your company name?
- Are you planning to keep the profits from the company? Or is your goal more focused on serving the community at large?
Answering some of these basic questions will point you in a general direction toward one type of entity over another.
What are the most common types of business structures for small businesses?
When many people think about choosing a business entity, their first thought is about huge corporations, many of which are publicly traded. These are traditional C-corporations.
While that type of business structure works great for some companies, many entrepreneurs who are just getting started simply do not need that structure to hit the ground running. That type of corporate set up may be in your future, but it is often not a good option for those who are just starting out.
Instead, entrepreneurs may want to consider some other entity options that have excellent benefits without the corporate formalities required to create and maintain a C-corporation.
Sole Proprietorships and Partnerships
A sole proprietorship is by far the most common type of business structure. In fact, there are over 23 million sole proprietorships in operation in the United States today.
Part of the reason they are so common is that you do not have to take any extra steps to form this type of business. Instead, you simply file your taxes slightly differently; there are no formal requirements to start a sole proprietorship.
It is by far the easiest type of business entity to run because the filing and formal requirements are extremely minimal. However, that does not mean it is the best option for every business. Sole proprietorships do not give some of the many benefits that other entities offer, such as limited liability, the ability to have more than one owner, or any feasible means to attract investors.
Partnerships operate very similarly to sole proprietorships, but there is more than one person involved. Forming them is often just as easy as creating a sole proprietorship. However, general partnerships are arguably even riskier because someone other than you could bind the partnership and put your personal assets at risk if the partnership does not pay its bills or gets sued.
For many entrepreneurs, having a sole proprietorship or partnership may be a good starting point, but it should not be a structure that you use indefinitely in most situations.
Limited Liability Company (LLC)
A limited liability company or LLC is a hybrid business type that incorporates some of the best features of both a sole proprietorship (or partnership) and a corporation. The benefits of an LLC include:
- Limited liability. An LLC allows each owner to limit their liability to just the assets that the company holds. That means that, as long as certain conditions are met, each owner’s personal assets, like their house or car, are not at risk if the LLC does not pay its bills or gets sued.
- No limit to membership. You can have virtually an unlimited number of members of your LLC. You can even break down membership into classes, where certain members have more rights (such as to vote) than others. This can be a helpful way to attract investors.
- Fewer formalities than corporations. Compared to a corporation, there is far less paperwork and required annual or bi-annual filings and fees associated with forming an LLC. Forming an LLC is also often less expensive and time consuming compared to a corporation.
Many entrepreneurs overlook the possibility of creating a non-profit organization. However, if your goal is to help the community, creating a non-profit can be a great option. You are often better able to raise funds and ensure that your civil and social goals are met when you create a tax-favored non-profit compared to a for-profit company.
In a traditional C-corporation, the company is taxed at the corporate level first. Then, when income is divided up among the owners, that money is taxed again at their individual tax rates. In an S-corporation, this “double taxation” is completely avoided because the corporation is only taxed at the individual owner’s rates—there is no separate corporate tax rate that applies.
This structure is similar to an LLC, except that any funds paid to owners (that are not wages) are generally taxed at a lower rate as “distributions” rather than income.
Unlike an LLC, however, an S-corp has strict legal guidelines for formation and maintenance. There are some limitations on how you can generate income, too. For example, those who own an S-corp can only have up to 25% of their receipts from passive activities, like real estate investing.
Where can I get help choosing the right entity for my business?
Only you can decide which benefits are the most important for your situation, but Rocket Lawyer can help. You can get tailored legal advice in minutes from a Rocket Lawyer On Call®️ Attorney. It’s quick and straightforward—learn more about Ask a Lawyer. If you decide on an LLC, S-Corp, C-Corp, or non-profit as your business entity, Rocket Lawyer can help get your name checked and your paperwork filed with our Incorporation services. You do the fun. Let Rocket Lawyer do the legal.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.