Imagine yourself buying a wallet. Probably, you will prefer one that carries all your currency notes and dimes and credit cards. If you want to have more capacity for debit and credit cards, you will find one that has many pockets. Or you simply want a shiny wallet to flaunt and do not care about the carrying capacity.
When you consider numerous factors while buying a wallet, of course, you should not be hurrying in deciding on the business structure for your business plan. You should first outline your requirements, the things you visualize yourself in your business, and write those down.
The next steps are to understand the different types of business entities in the USA and study the pros and cons of each business entity. Not all structures are good or bad; they are characterized by the benefits they offer to the entrepreneurs and not by the disadvantages they can cause.
Hence, an entrepreneur should not take it the other way while choosing a business structure. He should look into a structure as to what he can seek from it and what can bother his business growth and survival. Once you understand the thin line of difference, you can indeed find the perfect business structure for your small venture.
Let us find out important factors that govern the different business structures:
1. Personal liability issues
Do you want your personal liability attached to the business? It means if something goes wrong in the later stage of your business, you could be paying out of your pockets. But remember that when personal liability is involved, it means the business is entirely yours. You have the ultimate freedom to choose and do not have to ask opinions from your team members.
But if you are scared of paying liabilities from your personal revenue sources, then forming a legal structure is imperative. Though your personal assets will still be exposed to some extent, you can even safeguard your business through the legal framework.
2. Distribution of profits
No matter how excited and passionate you are about your products or services, revenue-generation is one of your motives. But the issue crops up when there are multiple partners or owners; the distribution of profits needs to be done. Each business structure has a unique profit-sharing model, and the partners or owners have to abide by the same. If you distribute in the wrong way, legal action can also be taken by other members of the organization. Hence, follow the framework of your selected business entity. If you are looking for venture financing or other modes of financing, then a corporation will serve as the best business structure.
3. Tax code
One of the things that tax your decision in choosing a business structure is the tax code. Remember that the more legalized and formal the business entity, the more flexible are the tax implications. We know how complicated a tax structure or a regulation can get, and hence, it is advisable to seek an expert opinion in this matter. Do not decide all by yourself as you cannot learn the entire tax code overnight or even in one week. Tax implications depend largely on the kind of ownership you have, and how profits are distributed amongst the owners.
4. Freedom to make decisions
You plan to start a small business because you have something to sell and would like to sell it in your own way. Or else you prefer to be an employee and not start any side hustle in your free time. This freedom attracts entrepreneurs from all corners of the world to invest and initiate their business ventures. In the beginning, everything might seem smooth, but as your organization expands, the need for a clear authority line arises. Hence, be vigilant in the initial stages and make the right choice.
5. Cumbersome compliance procedures
As you choose a legalized business structure, compliance becomes evident and a part of everyday life. Even if you choose a company, understand there are going to be different compliance measures for each type of company. Before you pick up one, ensure that you know how cumbersome it will be following the compliance system. Do not worry; everything is manageable, but ignorance is not an excuse for compliance.
We cannot announce your decision about the business entity to be chosen. But we can surely guide on how different each business entity is. So, in the next part of the article, we will list out all the takeaway factors.
Things to consider before picking up any kind of business structure. Let’s move!
#1. Sole Proprietorship
- No major legal compliance and maintenance.
- Can file tax returns along with personal ones.
- Personal liability for the business debts. Ease in attaching personal liability with business liability.
Things to consider seriously:
- Your personal assets are at risk when the business suffers.
- The best way is to stay as a one-person business but create a new business entity to safeguard your personal assets.
#2. Partnerships (The popular ones are General Partnership and Limited Liability Partnership)
- General partnerships are similar to a sole-proprietorship, and hence, it is advisable to form limited liability partnerships to seek benefits.
- It protects your personal assets as your liability is limited.
- Tax flexibility is a major benefit.
- There is a prior decision made regarding ownership and decision-making authorities. So, there are no conflicts later.
- Partnership agreement dictates profit distribution aspects.
Things to consider seriously:
- Lack of flexibility and ownership issues.
- Stringent compliance of procedures such as meetings.
- Constant need to revise the agreement.
- Tax issues when the business expands.
- It is advisable to convert the limited liability partnership into a corporation when the business makes substantial profits.
#3. Limited Liability Companies
- LLC is much better than an LLP as it saves tax concerns and resolved ownership issues.
- Easy and reasonable to maintain.
- Flexible in forming lines of authority.
- LLC can be formed by partnerships, LLCs, and even corporations.
Things to consider seriously:
- Not completely formal for a big business.
- Tax issues might arise.
- Annual maintenance is expensive.
- More formal and structured.
- Suitable for big businesses having multiple owners.
- Tax benefits, better credit structure, and investment opportunities.
- Increased credibility.
Things to consider seriously:
- Complex, expensive, and not suitable for small business entities.
- Corporate maintenance is mandatory and time-consuming.
- Double taxation possibilities might arise.
Briefly, no business structure is perfect or imperfect; each one has its pros and cons. An entrepreneur must not judge these business structures but select the right one as per his and team’s requirements. Be open to change. For instance, you might start a sole proprietorship or a partnership in the beginning and transform into a corporation as your business expands.
There are four common types of business structures in the United States: sole proprietorships, partnerships, corporations, and limited liability companies (LLCs). Each structure has its own advantages and disadvantages.
Sole proprietorships are the most common type of business in the United States. They are easy to form and have relatively few regulations. The main disadvantage of a sole proprietorship is that the owner is personally liable for all debts and obligations of the business.
Partnerships are similar to sole proprietorships, but there are two or more owners. Partnerships can be either general partnerships or limited partnerships. General partnerships are more common and have the same advantages and disadvantages as sole proprietorships. Limited partnerships have some additional advantages, such as the ability to raise capital more easily, but the main disadvantage is that the limited partners are not personally liable for the debts and obligations of the business.
Corporations are more complex than sole proprietorships and partnerships. They have many more regulations and are more expensive to form. The main advantage of a corporation is that the shareholders are not personally liable for the debts and obligations of the business. The main disadvantage is that corporations are taxed at a higher rate than other business structures.
The tax implications of each type of business structure are as follows:
Sole proprietorship: The sole proprietor is personally liable for all business debts and taxes. The sole proprietor reports business income (or loss) on their personal tax return.
Partnership: Partners are personally liable for all business debts and taxes. Partnerships file a partnership tax return and each partner reports their share of the partnership’s income (or loss) on their personal tax return.
Corporation: Corporations are subject to corporate income tax. Shareholders of a corporation report dividends received from the corporation on their personal tax return.
S-Corporation: S-Corporations are subject to corporate income tax. Shareholders of an S-Corporation report their share of the S-Corporation’s income (or loss) on their personal tax return.
The liability risks of each type of business structure are as follows:
Sole proprietorship: The sole proprietor is personally liable for all debts and obligations of the business.
Partnership: Partners are jointly and severally liable for all debts and obligations of the business.
Limited liability company: Members of an LLC are not personally liable for the debts and obligations of the business.
Corporation: Shareholders of a corporation are not personally liable for the debts and obligations of the business.
The asset protection benefits of each type of business structure are:
Sole proprietorship: This business structure offers the least amount of asset protection. The owner is personally liable for all debts and liabilities of the business.
Partnership: A partnership offers some asset protection to the partners. Each partner is only liable for their own actions and not for the actions of the other partners.
Limited liability company (LLC): An LLC offers the most asset protection to the owners. The owners are not personally liable for the debts and liabilities of the business.
The overall considerations when choosing the right business structure for your small business include the following: the business’s legal structure, the business’s tax obligations, the business’s liability protection, and the business’s ability to attract investors.