Your business’s ownership structure is an essential element that determines its function in your community. It’s one of the first decisions you’ll have to make as an entrepreneur, so you must use your long-term business goals and current financial situation to guide your choice.
The legal structure you choose for your company will define which tax forms you use and how much personal liability you’ll have should something go sideways with the business. Consider the most common business ownership structures to find the option that best serves your business’s unique needs.
Sole Proprietorship
If you’re a solo business owner who prefers to work alone, a sole proprietorship structure may serve you well. This legal structure is often used by people who run small businesses out of their homes, like daycare centers and online boutiques. Many sole proprietors secure startup funding through a small business loan company to get their ventures off the ground.
Keep in mind that if you do set your business up as a sole proprietorship, you retain all legal and financial liability. If your business falls deep into debt, or if you are sued by an unhappy customer, you are personally on the hook for those expenses. Sole proprietorships work best for businesses that don’t carry much inherent risk with them.
However, there are several unique perks to setting up your business as a sole proprietorship. Going it alone for your first business venture offers the following advantages:
- You retain sole authority over all business decisions.
- The startup process is easy—no complex forms or government fees required!
- Tax season is straightforward; you report your business income on your personal form.
- There is no need for annual financial disclosure reports, offering you greater privacy.
Partnership
Have you started a new business with a friend or colleague? If two or more people are collaborating at the helm of your small business, consider structuring your company as a partnership. This legal setup allows brand-new business owners to test out their ideas more informally before creating a formal company.
General
If you want to incorporate your company as a general partnership, keep in mind that you and your partners will have equal roles and responsibilities in the business’s day-to-day operations.
Business owners under a general partnership still hold unlimited personal liability. Similar to sole proprietorships, if your company falls into financial trouble, you and your partners will be personally liable for those debts.
In addition, partnerships are tax-reporting entities, not tax-filing entities. You and your partners will report your business income on your personal tax returns.
Limited Liability
While business co-owners under a general partnership hold unlimited liability for the business’s finances, some entrepreneurs opt for a limited liability partnership (LLP). The LLP structure limits each partner’s personal liability and spreads that risk evenly among the partners.
This is a good legal structure for businesses that carry a little more risk, as well as for owners who want to keep their personal finances protected. Law firms, medical practices, and wealth management companies often incorporate as LLPs.
Corporation
If you want to place a more formal division between your personal and business finances, consider structuring your business as a corporation. In the eyes of the law, a corporation is an entirely separate legal entity from its owner or owners. This structure entails quite a bit more paperwork, but it can pay off in the long run.
There are a few different types of corporations, each with their own unique benefits.
C Corporation
A C corp is often simply called a corporation and is completely separate from its owners, both legally and financially. This is a major benefit for entrepreneurs who want to keep their personal finances safe from liability. However, corporations are also more expensive to set up and require more paperwork and reporting to remain compliant with IRS regulations.
Still, structuring your business as a C corp. gives you unique financial opportunities. You can finance your new corporation by selling stock in the company and building a solid foundation on which to grow your business. Plus, if your business is highly successful, you can become a publicly traded company—often called “going public” in the business world—and allow people to buy stock.
C corporations are double-taxed in many instances—first on profits, then on dividends received by stockholders. If you’re incorporating as a C corp., make sure you have a talented accountant on your side come tax season.
Good To Know:
If you plan to roll over your 401(k) retirement funds to finance your new business, you’ll have to set your business up as a C corporation first. Creating a new 401(k) program and offering employees the option to invest in it is a crucial step in a Rollover for Business Startups (ROBS).
S Corporation
If you balk at the prospect of double taxation on a C corp., consider passing some financial responsibility on to your shareholders. S corporations are ideal for businesses with multiple owners and a board of directors or trustees. With this structure, shareholders report business profits and losses on their personal tax forms, and the business entity only pays one level of federal tax.
However, S corporations aren’t for everyone. Your company must meet the following criteria in order to qualify:
- No more than 100 shareholders in total
- Shareholders must be US citizens
- Corporation must be domestic in nature
Limited Liability Company (LLC)
This structure is not to be confused with a limited liability partnership, though there are several similarities. LLCs are a unique hybrid of sole proprietorships, partnerships, and corporations. Much like a corporation or LLP, the LLC structure limits owners’ personal liability and ensures that only business assets can be used to pay off debts.
Tax-wise, LLCs are more complicated than partnerships but less so than corporations. You must file your LLC paperwork with your Secretary of State. And while you won’t be subject to the same federal taxes as a corporation, you may be responsible for additional state taxes.
As you lay the groundwork for your new business venture, think about the business ownership structure you want to use. The most common legal structures each have their own risks and benefits; therefore, one of these options may be better for your unique situation than the others. Consider your personal financial circumstances and the nature of your business idea as you decide on a structure.
Wondering about the startup funding options available to you? Use Pango Financial’s funding solutions tool to learn more about financing strategies for which you may qualify.
