Planning to start a new business?
Do you know which business structure would be the right choice for you?
As a new business owner, you might already have a lot on your plate with regards to your liability, taxes, and more. Selecting the right structure plays a crucial role in all of these decisions.
For most small businesses not wanting to form a partnership, the three common options are Sole Proprietorship, Limited Liability Company (LLC), and Corporation.
Each of these structures has their own benefits and drawbacks, making it very important for a businesses owner to understand their differences.
While it is not wrong to rely on your legal team to make the right decision, as a business owner you too should know at least the basics of these different types of business structures.
If you’ve already tried understanding the differences but all the legal mumbo-jumbo have only resulted in more confusion, this post can definitely help.
It attempts to help you understand these common business structures in the easiest possible manner.
So, what are you waiting for?
Let us begin.
As compared to a corporation or LLC, a sole proprietorship is the easiest way to start a new business. Apart from obtaining the required business permits and licenses as per the state and country laws, a sole proprietorship does not require any legal action. It primarily operates as an extension of yourself, and you and your newly formed business have no legal distinctions.
As a matter of fact, even the profit and loss statement of your business flows directly through your tax returns. In simple words, all the profits you earn is reported as your individual income and taxed accordingly.
The major demerit of this business structure is that the owner is responsible for all the liabilities. This means in the event when the business fails and is sued by someone, the court may attach personal assets of the owner to recover the damages.
The majority of the small businesses, as well as home-based businesses, thus prefer sole proprietorship as it is the least complicated structure.
A Limited Liability Company (LLC) is a preferred option for new businesses looking for legal protection. Unlike sole proprietorship where the business owner is responsible for all the financials and legalities, the business owner, as well as the directors of the company, remain legally protected in case of an LLC.
However, if you’re the sole owner of the business but still form an LLC, the IRS would generally continue to treat your business as a sole proprietorship. In such cases, your tax returns and business income are treated just like sole proprietorships.
To form an LLC, you’re required first to file the appropriate documents which vary across the states. Generally, you’ll be required to select the business name, select the registered agent, file article of organization and draft an operating agreement.
While home-based businesses prefer sole proprietorship, if you know you’ll be dealing with a lot of money, clients, and customers in future, it is better to form an LLC as it’ll provide legal protection.
Many of the businesses start as a sole proprietorship and then switch to LLC.
A single or multiple stockholders own a corporation. The stockholders elect the board of directors for the company. The board can also have a single director.
It is the responsibility of the director’s, to appoint the officers who’ll handle the business operations. Just like LLC, the directors, officers, as well as the stockholders of the company are legally protected against company liabilities in the case of corporations.
Unlike sole proprietorships, corporations are separate entities whose taxes are separately filed. The federal income tax for corporates are not within the graduated tax brackets, and in a lot of states, they’re also required to pay franchise tax.
To start a corporation, you’d at least have to file the articles of incorporation and create bylaws. Apart from this, the other requirements generally vary between states. Corporations that have a lot of stockholders are also required to register themselves with SEC for issuing shares. However, smaller corporations that only have a few stockholders are allowed to apply for an exemption of filing.
A corporation is generally a preferred option for new business if there are multiple business owners who are investing a lot of money in it. If you also plan to raise more funds by selling company shares, you’ll have to form a corporation.
While a large number of small businesses generally prefer sole proprietorship, but LLC is generally the best option to go for. The primary reason being the limited liability protection and taxation flexibility.
Now that you understand the differences, you can now sit with your legal team to discuss the advantages and disadvantages of these structure options and make the best decision for your new business.