If there is one thing we’ve learned from over a decade and a half of helping small business owners, it’s that every business is different. For new small business owners, it’s important that you choose the business entity that will suit your unique needs. There are four basic entities that you can choose from, each with its own advantages and disadvantages. While there is no “right” choice, depending on what you sell, where you plan to take your company, and how ownership of the company is divided, there will be certain entities that will fit your business model better than others.
Sole Proprietorships and Partnerships
Sole proprietorships and partnerships are the simplest type of business entity. They are also the default option. It doesn’t take much to start a sole proprietorship or a partnership either. Just file for a ‘Doing Business As’ name, apply for the right licenses and permits, and open your doors. If the business is run by two or more people, you will also need an Employer Identification Number (EIN) and you’ll have to file another form come tax time. But this simplicity comes at a price. Everything the business owes and owns is tied to your personal assets. In other words, you, and your partner if you have one, will be held liable for the business’s debts if it fails. Also, if you do have a partner, you may not be protected if they decide to walk away from the business. So, while running a sole proprietorship or partnership is a lot simpler, it does put an undue amount of risk on the owner(s). To limit your liability, consider forming a corporation or limited liability company.
Corporations are a very common type of entity. There is a lot of history, and plenty of laws, behind this entity, which makes running one fairly complex. Now, by incorporating you are greatly reducing your personal risk and protecting your assets by creating a separate, legal entity. And you can sell shares of the company to help raise money. However, this entity will be expected to report income and pay taxes, which can make accounting a bit difficult. Your compensation will come out of the corporation’s profits as well, which means you could be paying tax twice – once at the corporate level, and again at the personal level. Electing to be taxed as an S-Corporation solves this issue by allowing profit to pass through the corporation, untaxed, directly to the shareholders, but not every state recognizes the pass-through structure of an S-Corp. Corporations are also a bit difficult to run. You have to have board meetings, shareholder meetings, annual meetings, and debate and record every major business decision. Corporate governance isn’t for the faint-hearted, which is why so many people choose to form an LLC instead.
LLCs are rapidly becoming on of the most popular type of business entity because they provide the owner, or owners, with the same limited liability as a corporation, while being much easier to run. LLCs, by default, also have a pass-through tax structure, which means you don’t have to file for anything to avoid double taxation. LLCs do not have shares to sell, so you cannot raise money through investment, but the loss of shareholders means fewer meetings. There is no board of directors to worry about, or executive committee to run ideas through. Really, it’s just you, your partner if you have one, and your business. Just remember that an LLC is a separate legal entity so, though not legally required, you should have an operating agreement in place and document any major business decisions, just so you can prove you aren’t running your LLC like you would a sole-proprietorship.
Have any questions about the different types of entity? Wondering which business entity is right for you? Leave a comment below, or give us a call at 1 (877) 692-6772, and we’ll be happy to help you out!