Choosing your company structure is a big step. It defines who owns your company, who is responsible for its debts, and how taxes will be paid. Although you can change your company structure at any point, it’ll save you time and money to choose the best one for your needs at the onset of formation. In order to determine what structure is best for you, we’ll explore the most common business structures and types.
If you own your business alone and want to report your profits on your personal tax return, a sole proprietorship is the simplest place to start. However, it’s important to remember that you’re ultimately liable for your company’s debts, so if something goes wrong, your personal assets could be at risk. For many people, this is not a concern, but if there’s any chance your company could unintentionally cause monetary losses for someone else, you may do better with the protections afforded by the structure of a limited liability company.
For example, a customer tripping on the pavement outside your office, selling faulty goods, failure to make good on a bank loan, or similar issues could leave you personally accountable, so it’s important to be especially mindful about the risk you’re accepting by operating as a sole proprietorship. About 70 percent of small businesses are sole proprietorships, according to IRS data. This group includes many people who do contract work or work from home and many types of professionals, from accountants to consultants.
If you share ownership with one or more people or organizations and expect all owners to report profits on their individual tax returns, a partnership structure is the most straightforward option. There are a few different types of partnerships to choose from.
General partnerships work much like sole proprietorships but include multiple owners. Like the sole proprietorship, liability ultimately rests upon the owners of the business. That said, the owners also manage the business and have the legal ability to make business decisions and sign contracts on behalf of the business, too.
Businesses with shared ownership will usually have limited partners, meaning their liability is limited, and general partners, meaning they can be personally held liable for all the business debts. Limited partners do not make decisions for the company and may not even have a role beyond investing in the business, while general partners handle management aspects, and are therefore responsible for the outcome. Under a limited partnership, it’s possible to have both limited partners and general partners, but even then, the limited partners are still not wholly protected. They can be held liable up to the amount of their investment. This type of structure is common in real estate.
Limited Liability Partnerships (LLPs)
The concept of having both general and limited partners continues with limited liability partnerships. Limited partners under this structure are not held liable for the actions or negligence of other partners. It’s common to see those providing professional services, such as lawyers and physicians, operate under an LLP.
Limited Liability Limited Partnerships (LLLPs)
With a limited liability limited partnership, general partners are protected from liabilities related to the other general partners. In these cases, the general partners will take on management roles and the limited partners are silent but have a financial stake in the company. LLLPs are mostly used in real estate and are not recognized in all states.
Limited Liability Company (LLC)
With an LLC, profits can be taxed at a personal level or corporate level and liability for business issues is limited, so owners are afforded some personal protections. If you operate a business and have any type of concern that an error or negligence could result in losses which could cost you your home, savings, and other assets, you’ll likely want to form an LLC or corporation.
With an S Corp, there can be as many as 100 stockholders, profits are taxed on the stockholders’ returns, and liability is limited. Only one class of stock is permitted and there are some restrictions on who the stockholders may be.
Liability remains limited under a C Corp, but restrictions on the number of stockholders is lifted as are classes of stock, though profits are taxed at a business and individual level. These tend to be best for seriously growth-minded individuals who plan to raise a lot of capital or expect to be publicly-traded.
Still Not Sure Which Business Structure is Right for You?
Ask Yourself These Five Questions.
1. How much personal risk can I accept?
If there’s any chance your business could develop debts that might result in collectors coming for your assets, you may prefer to go for an LLC or corporation.
2. Am I comfortable with formal and complex arrangements?
When it comes to partnerships, you and your partners define what happens with profits or when someone leaves the business. On the other hand, because corporations have shareholders, the law requires them to have a board of directors who oversees all decisions in order to protect the interests of the shareholders. Establishing a corporation is also far more complex. Most business owners require the assistance of accountants and lawyers to get set up and remain compliant with all legal requirements.
3. Am I OK with profits being taxed twice?
Operating a C corporation provides more flexibility on who can own stock and what forms of stock can be offered. It’s important to remember, though, that profits are taxed at the business level and then must also be reported as income for the shareholders.
4. What will I do when my business needs funding?
Almost all businesses need funding to help grow at some point. As a sole proprietor, you will likely need to use your own cash or improve cash flow through options like invoice factoring. Chances are you will be unable to secure a business loan from a bank. If you plan to seek help from angel investors or venture capitalists, they will want a stake in your company in exchange for the cash they inject. You’ll need to form an LLC or corporation in order to give them a piece.
5. Where do I see my business in five or more years?
Sole proprietorships, LLCs, and partnerships are simpler to establish and run. They can work very well when you and everyone involved gets along well and are diligent in your planning. However, if you think you’ll need the help of venture capitalists, plan to become a publicly-traded company, or have concerns over what might happen if one of the company owners cannot continue with the company, a corporation may be the better choice.
Need a Cash Injection Now?
At Interstate Capital, we help all types of businesses improve cash flow with invoice factoring. In short, if you send your clients invoices for work completed or goods delivered, we can provide you with immediate payment and will take over the billing process on those invoices. To learn more, download our free factoring guide.