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Deciding on a Business Structure
A common question from new business owners is “What is the best business structure?” Unfortunately, there is no simple answer that works for everyone. The type of business structure that is best for any business is dependent on the endless variations in what a business will do and how it will do it. A brief explanation of some of the most common kinds of business structures may be helpful in getting an idea. However, until you have a clear picture in your mind of what your business will look like, it is going to be very difficult to intelligently decide which business structure will best meet your needs.
Sole proprietorship is the most common type of structure in America. This structure has a single owner and there is no legal distinction between the owner and the business.
It is exceptionally easy to organize and get started, requiring no capital and little to no paperwork to file. The owner enjoys a high degree of flexibility and runs the business as they wish. Some creditors are willing to loan to sole proprietorships knowing that the owner is on the hook for repayment and there is no “corporate veil” to hide behind should the venture fail. Finally, the owner of the sole proprietorship gets all the profit and has no need to report earnings publicly. The owner is taxed based on if all revenue and expenses are income and expenses. Again, this is simple.
On the down side, the owner is fully exposed to liability. Sole proprietorships generally are underfunded and have a hard time raising needed funds from traditional sources because they commonly fail. The business does not continue past the death of the owner. Taxation is simple, but the owner does not enjoy many tax advantages to business activities.
Partnerships share many characteristics with sole proprietorships except they are owned by more than one person. It is defined as a business organization in which two or more individuals manage and operate the business; where owners are equally and personally liable for the debts from the business.
Like a sole proprietorship, a partnership is easy to organize, requires no capital, is flexible, and enjoys privacy.
Also like a sole proprietorship, however, a partnership leaves the owners exposed for business liabilities, including those incurred by other partners. Partnerships, however, are often not as underfunded since one partner is often brought in for that very purpose.
A C- Corporation is its own legal entity distinct and separate from any of its owners, managers and employees. C-Corporations’ biggest advantages come in the liability protection they provide to their owners and the ability to raise capital. Because C-Corporations are their own legal entity, essentially a legal person, they can live on despite changes in ownership.
C-Corporations require a large amount of capital, require legal formalities that continue throughout the life of the corporation, and end up with something termed as “double-taxation”. The taxation is such that the Corporation must pay taxes based on its activities, independent of any of the earnings of its owners. When the owners receive compensation for the work they do with the Corporation, they are taxed on that income.
The S-Corporation has gained recent popularity, along with Limited Liability Companies “L.L.C.’s”, partially because it offers similar liability protection to owners, but avoids double-taxation. S-Corporations are often a better option for smaller start-ups without major investors bank-rolling the project. It can live beyond the owner(s) and provides a structure for raising capital and transfer of ownership.
It still requires corporate formalities for start-up and to be filed continuously with the Corporation Commission.
Limited Liability Company- L.L.C.
Like S-Corporations, L.L.C.’s allow the owners to protect their personal assets or avoid personal liability for the business and the ability to limit taxes. Other factors, however, will determine whether an L.L.C. or an S-Corporation is better for a given business model. L.L.C.’s are particular on defining principals as either managers or owners. The day to day of operations and the situation with ownership will be determining factors.
Before you decide on a business structure, create a business plan and have a clear understanding of what your company is or will be. Look into the future and where you want the company to be in 1, 5 and 10 years or beyond. An experienced business attorney will be able to take all the variables and educate you on how the structure of different businesses may impact your business in the short and long term. Having this input before you decide on a structure can save you time, money, headaches and will be more than worth the investment.
Published By Brad Denton
40 N. Central Avenue, Suite 1400-1532
Phoenix, AZ 85004
GDP Business Blog
Mesa, AZ 85213