Starting a small business is an exciting milestone in your entrepreneurial journey. You’re turning your dream into a reality and offering new products and services that can benefit the lives of customers. After drafting a business plan, it’s time to look into the right business structure to incorporate as.
Which entity should you choose? Entrepreneurs have several options available to incorporate as including but not limited to the following business structure formations.
- Sole Proprietor
- Limited Liability Company (LLC)
- Partnership
- S Corporation
- Nonprofit Corporation
Let’s explore each business structure and determine whether it’s the right fit for your startup.
Sole Proprietor
Incorporating as a sole proprietor allows you to be the sole owner of the business. This means you, and only you, calls the shots. Certainly, it’s the perfect entity for anyone who wants to be the boss of their startup and assume responsibility for everything.
However, there is a downside to incorporating as a sole proprietor. This business structure does not provide its owner with liability protection. Liability protection creates a separation between personal and professional assets. For example, let’s say something unforeseen were to impact the business, such as a lawsuit. Liability protection ensures that there is no impact to the owner’s personal assets.
Above all, be mindful that there is no liability protection if you incorporate as the sole proprietor structure. As a sole proprietor, you would be held liable for everything that affects the business — good and bad.
Limited Liability Company (LLC)
As a business structure, limited liability companies (LLCs) offer plenty of benefits. Unlike sole proprietorships, LLCs have liability protection. This legally separates the business from its owner, or member.
In addition to liability protection, LLCs are a flexible entity. It’s a little bit easier to calculate and pay taxes as an LLC. You even get to choose the way you’d like the LLC to be taxed, which can range being taxed as a partnership to an S Corporation.
But, LLCs may also be incorporated under various LLC structure types depending on its number of members. These include single member LLCs, member managed LLCs, and manager managed LLCs. Let’s briefly define each one.
- Single Member LLC. It’s exactly what it sounds like — only one member runs the business.
- Member Managed LLC. Here, every member is treated and managed as an equal. Under a member managed LLC, all members share the same amount of responsibility in the LLC’s day-to-day operations.
- Manager Managed LLC. This specific type of LLC is ideal for members that may need a little help running the LLC. A board of managers is appointed in a manager managed LLC. This board oversees the direction and operation of the LLC.
Partnership
For example, have you ever thought about going into business with a family member or friend? You may consider incorporating as a partnership. This business structure establishes an agreement between two (sometimes more) individuals interested in going into business together. They split costs and profits and make decisions accordingly.
Similarly, there are several different types of partnerships that may be formed by entrepreneurs. Some of these include joint venture, silent, and limited liability partnerships (LLPs). Typically, small business owners will opt for a general partnership structure. Under a general partnership, all profits, liabilities, and management duties are divided equally with partners. It is advised that a written partnership agreement is put into place, too. This ensures that each partner understands their roles and duties within the partnership, as well as the structure’s terms and rules for admittance and exits.
S Corporation
An S Corporation is one of the few business structures that begins as a different entity. An S Corp is initially an LLC or C Corporation that files for S Corp status with the IRS. Doing this then makes it a C Corp with an S Corp tax election.
Having an S Corp tax election tells the IRS that the entity would like to be taxed as a partnership, instead of a corporation. Doing this ensures that the S Corp avoids double taxation. No double taxation is a big draw for incorporating as an S Corp structure! It means that an S Corporation elects to have profits, losses, deductions, and credits “pass through” the entity level. This means the S Corp is only taxed at the shareholder level. Its shareholders are only subject to paying employment tax.
Nonprofit Corporation
Nonprofit corporations are corporations founded for a charitable purpose. This type of corporation is formed to benefit the general public and pursue a social mission. Once you decide to form a nonprofit corporation structure, you must take care of a few extra steps outside of incorporation. Remember to create bylaws that establish how the corporation is operated, identify your nonprofit’s mission statement and its values, and file for the appropriate tax exempt status with the state and federal governments.
Many entrepreneurs choose to form entities, like Certified B Corporations and nonprofit corporations, that allow them to make a difference in business. Sometimes that difference goes well beyond the business itself. Above all, it allows entrepreneurs to change the world!