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How to Choose the Right Business Entity Structure

  • Financing|
Published: 05/18/2018

Many entrepreneurs launching their own company feel a sense of immense pride–and justifiably so. Starting your own business is no small feat; it requires determination, planning, sacrifice, and investment. It also requires clerical tasks and paperwork. One of your most important administrative decisions as a new business owner is how to legally structure your firm.

A variety of structures are available, and there’s no one-size-fits-all approach. The appropriate structure depends on factors such as your available capital, the number of employees and owners, the amount of liability exposure you can afford, and so on. Here are a few tips on how to choose the right entity structure, so you can clear this administrative hurdle and get going with your business’s future:

Sole Proprietorships and General Partnerships

This simple structure is the most common business in the US, according to The Balance. In a sole proprietorship, the business is entirely owned by one individual, who is considered to be more or less the same legal entity as the business itself. Any business profits or losses must be tackled on your own personal income taxes, and you are personally responsible for any liabilities, such as debts or lawsuits.

Paperwork required to start varies by business type and location, but is almost always significantly cheaper and easier than most other business types. Small businesses typically owned and managed by one person, such as doctor’s offices or construction contractors, tend to be sole proprietorships. Funding for sole proprietorships can be tricky; because ownership is restricted, they can’t make money by selling stock in their own companies, and Bplans reports they often have a harder time getting loans than structures that are more difficult to establish.

General partnerships are very similar to sole proprietorships–they just involve shared ownership and management distributed between two or more individuals. All disadvantages and advantages of sole proprietorships are present. Sharing responsibility with another person can be either a management strength or a complication, depending on your relationship with your co-owner(s) and the size and nature of your business.

C and S Corporations

When you incorporate your business, you establish it as a separate legal entity from you or any other individual owners — no more lumping your business losses and gains in with your personal income tax. The process of incorporation can be lengthy, complicated, and onerous. FindLaw’s checklist for starting a corporation includes creating articles of incorporation, by-Laws, and a shareholder agreement, as well as hiring a board of directors. I may take time, but this laborious process can be worth it.

Owners no longer have personal liability for any debts or damages assigned to the corporation, and gaining shareholders through stock can help the company raise money and grow (though these people, of course, also gain a say in how the company is run). Though corporations can be tough to start from scratch and are often associated with monolithic companies in the popular imagination, small businesses can become corporations, too. If you incorporate your business, you automatically create a C-Corporation.

Biz Filings reports many small businesses eschew this structure because of “double taxation,” when company profits are taxed once through the corporate entity, and then again when dividends are distributed to owners as personal income. S-Corporations are generally considered friendlier structures because all income tax is paid on owners’ personal tax returns. While C-Corporations can have unlimited owners, S-Corporations are limited to 100 or fewer and face some other restrictions on their stock and membership.

Limited Liability Company

Investopedia defines LLCs as “essentially hybrid entities that combine the characteristics of a corporation and a partnership or sole proprietorship.” LLC owners, much like corporation owners, are largely protected from their business’s debts and liabilities. And, much like S-corporations, their profits pass directly through owners’ tax returns, lessening “double taxation” (though the specifics of how these taxes work are different, and your choice could affect the amount you pay–a CPA with The Balance explains some of the differences).

Investopedia also observes that corporations (including S-corps) generally provide stronger liability protection than LLCs, but can be significantly more complicated to set up and manage. If managing autonomy is essential for you, an LLC might be the better choice. LLCs can have unlimited owners like C-Corporations, but they also may face some obstacles corporations don’t, such as automatic dissolution upon a member’s death and more complicated transfer of ownership (a serious issue if you later decide your company should go public).

Limited Partnerships

Limited partnerships, much like general partnerships, are when two or more people join together to own and manage a business. In limited partnerships, however, one or more partner is the “limited partner” and is only liable for the company to the extent of their initial investment. Limited partners can contribute financially to the company and enjoy its profits, but can’t become involved in any kind of management decisions.

NOLO reports that a creditor pursuing a general partner’s personal assets can go after a limited partner’s assets as well, if they can prove that any illicit active business decisions were made. A limited partnership may be a great option if you have a business partner who’s willing to provide low-risk capital while leaving the day-to-day management decisions to you.

Other business structures exist, the Small Business Administration lists some others here, but these are generally the most common and useful structures for small firms just starting out.

If you’re interested in learning more about ways you can optimize your business’s financial standing, don’t hesitate to reach out to our Specialists at Currency. We’re always available for a call at 877-358-4595, and would love to answer your questions and guide you toward the best option for your business.

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