As an entrepreneur, it is a wise financial move to choose an entity structure for your new business. Selecting a structure establishes a clear system for paying taxes and paying yourself (and any employees) an income, as well as protecting your personal wealth and assets from disasters that could impact your company. The question you should focus on as a business owner is, which entity structure is right for your business?
If you’re obsessed with complete and total control over the direction of your business, a sole proprietorship is the best option for you as a small-business owner. It is the most common form of business organization, largely because it is easy to form and offers complete managerial control to the owner. However, it is important to keep in mind that you, as the owner, are personally liable for all financial obligations of the business. If your business accrues debt, your personal finances could be targeted by your creditors.
When two or more people agree to share in the responsibility for, and profits and losses of, a business, it is considered a partnership. The main advantage is that the tax burden of profits and benefit of losses is not the partnership’s problem, but rather, is passed on to the partners to report on individual income tax returns. On the other hand, each partner is personally liable for financial obligations of the business.
A corporation is a legal entity that is separate from those who founded the business. Companies can be taxed and held legally responsible for actions, with no personal liability to the founders. However, corporations are expensive to form and have extensive documentation requirements that must be followed.
Limited Liability Company (LLC)
The LLC is a hybrid form of a partnership. An LLC allows owners to take advantage of the benefits of corporations and partnerships. Profits and losses can be passed along to owners without the business facing taxation, while shielding owners from personal liability.
C-Corporations are ideal for startups because it is designed for businesses in the early stages of development. C-Corps are particularly attractive to venture capitalists because they offer a safe investment for venture capital firms. Other advantages include the separation of debt, tax, and legal liability from personal assets.
An S-Corp separates your personal assets from your company’s debts and provides some tax benefits. The biggest advantage is the ability to avoid corporate income taxation with an S-Corp. It allows you to limit the number of shareholders in your new business, but will not attract a lot of venture capitalists because you can only issue one class of stock. This minimizes the ability to seek multiple financings.
As you read more about each of these business-entity structures, you may feel confused as to which one best suits your company. While reading through the options, the most important factors to keep in mind are legal liability, tax implications, cost of formation, flexibility, and the future needs of your business.