A lot more goes into deciding what entity you should choose for your small business than what looks nice on the business card. There are a number of things to take in to consideration and your decision can affect the way your company operates.
Think about what could happen if business takes a downturn. An entity with liability protection can help keep you personally insulated (to an extent) from the storms your company might need to weather.
Whatever you choose, you’re going to be stuck with for some time. While it is possible to change entities, it’s frowned upon and you can expect some tax headaches. Do your research and make the best decision that works for the foreseeable future.
A sole proprietorship is one of the simplest and most direct ways of creating a company. This can be very tempting as you yourself are the business and your income made is taxed as personal income. Unlike the other types of structures in this list, sole proprietorships are not legal entities.
An individual can start up a sole proprietorship very quickly and inexpensively. Business is conducted under the owner’s name or a fictious company name. The company name has no ties to an actual legal entity, it’s just another name for the business owner to use.
Another one of the advantages of sole proprietorships is the ability to mix “company” and personal assets. Since an SP isn’t a legal entity, assets aren’t viewed the same as they are in other entities on this list.
While this lack of complexity may seem enticing, there are some issues you should be aware of. First and foremost is you have no personal protection if business goes south. If you rack up some debt and are no longer able to pay it; creditors (and plaintiffs) can come after you personally.
Another grim scenario you could find yourself in is the injury or death of an employee. All liability rests on your shoulders so this becomes personally your responsibility.
A sole proprietorship means there’s no protections, if something goes wrong, it’s all on you.
A partnership is any business that has more than one owner. There are a couple of different types of partnerships that are better suited for different situations.
A general partnership is a company owned by individuals who have not filed for an LLC or corporation status. General partnerships share a lot in common with sole proprietorships but with more people. If anything happens, everyone involved with the partnership is liable. Each owner of the company can be held responsible for debts, injury, accidents, etc.
A limited partnership (or LP) is a company run by a combination of “limited partners” and “general partners.”
General partners actually run the business and can be held personally liable for any issues the company might run into.
Limited partners are investors that have little to no involvement in the company itself. This type of partner can not be held personally liable for the business.
As far as taxes are concerned, each partner pays taxes on the profits they make personally. This is a nice advantage over a corporation. Corporations are taxed at the corporate level and also pay taxes on the dividends distributed to shareholders.
Limited Liability Partnerships
Limited Liability Partnerships (also called an LLP) are partnerships completely run by limited partners. This means every partner in the company has liability protection. This type of company is most used by groups of accounts, lawyers, or other professionals.
Limited Liability Company
A limited liability company (or LLC) is another one of the more simple types of business structures. In an LLC, the owner (or owners) has liability protection and can not be personally pursued if anything happens to the company.
LLC owners are also only taxed on profits. However, they are subject to self-employment tax, which is up to 15.3 percent. Generally speaking though, LLC owners benefit from an extra level of credibility as well as having their personal assets protected. Unfortunately, the way LLCs are treated state-to-state differ, so it’s important to do your research and find out exactly what to expect for your state. If it looks good for your state, and you don’t plan on issuing shares to investors; an LLC might be the right choice for you.
The scope of this article is to focus on legal structures you may use for small business. Because of this, we won’t be diving too in-depth on corporations. However, if you’re small business experiences some awesome growth, here are some things to keep in mind about corporations.
C Corporations are also called “C Corps” or just “corporations.” C Corporations have the ability to sell stocks to shareholders to get investments. The large companies that are traded on the stock market are usually C Corps.
There are a lot of advantages to a corporation, primarily, the lower corporate tax rate. However, a corporation must hand over a lot of different business and financial information to the government.
An S Corporation is mostly the same as a C Corp. The main difference is, an S Corp may not have more than 100 shareholders. Shareholders in an S Corp can not include non-resident aliens, partnerships or corporations.
There are some other, less common business structures out there. But, these are some of the most common a small business owner might consider. We hope this has been a great introduction to get you on the right track for your small business!