When you start building your business, there are so many crucial questions you need to answer from the very first steps you take into the entrepreneurial world. However, a top priority among them should be choosing a suitable legal structure that will both protect your private and personal assets, and allow for the growth of your newly-founded business, in accordance with local, state, and federal law.
Your choice will affect numerous aspects of your operation — from tax benefits and obligations, the level of liability, the boundaries between your personal and business assets, all the way to the amount of paperwork you’ll need to handle on a monthly and yearly basis. If you’re still wondering what the best solution would be for you, take a look at these basic legal structures to consider for your business.
Considered the simplest legal structure that requires conveniently little paperwork, a sole proprietorship is a form that is demanding for your energy, as well as your business savvy, since the basic premise is that you are the sole owner and manager of your operations.
It also means that there is no viable difference between you as an individual, and your business, making you solely responsible for your potential business failures, so you need to be aware of the level of risk you are assuming with this structure. Since you are the business entity, you will be held accountable for all debt and losses that might occur during your company’s existence.
Bear in mind that this structure might hold a different name in various countries so it can be loosely translated as “sole professional” or “sole entrepreneur,” and it might include different taxing strategies, so make sure to be well informed before you settle for this solution.
Depending on your expertise and education, there could be various intricacies involved in obtaining proper licenses and protecting trademarks to make your business entirely legal and operational. For instance, if you are a medical professional, different countries require different levels of academic qualifications for obtaining a sole professional license.
On the other hand, if you are a freelancer who wishes to legalize their services, you would likely fall under the category of micro-entrepreneurship.
But look to your community — how many artisans and various service providers do you know that still create quite a buzz in your business world and earn a sizeable income solely on their own creative output and individual efforts? They might seem unimposing, but they certainly know how to make it in the market with a unique offer and plenty of hard work.
On a final note, make sure to comply with all the laws and regulations while setting up your business, and while most of the essential information can be obtained from your local business development center; you might wish to consult a legal professional to guide you through the process.
If you decide to expand your business or if the original idea was the result of mutual efforts, then it makes sense to form a partnership with one or more parties to share the responsibilities of your company. However, before you form a partnership, you will need to establish clear boundaries of responsibility, how you will share profits and losses, how you will handle decision-making, future employment, as well as the development of your business.
It goes without saying that trust plays a pivotal role in forming a partnership, as legally binding contracts and mutually beneficial strategies alone cannot be the sole basis of your future endeavors. You need to share the vision, goals, and beliefs for your business to succeed. Therefore, strive to establish a clear line of transparent communication and clear lines of authority.
Just like with sole proprietorship, partners share liability when it comes to potential losses and debts, which is considered as a disadvantage to this structure, but it can be easily manageable if you build your business on a strong foundation and with a clear short term and long term plan for accelerated success.
A shining example of a partnership that allowed for a soaring revolution of their business is The Baker Chocolate Company founded by chocolatier John Hannon and his partner, Walter Baker who was in charge of the business portion of their operation. Today, they are known by the name Mondelez International — need we say more?
As a more complex and pricier structure, a standard C corporation is recommended mostly for already established businesses that include several involved parties as well as employees in some instances. It takes more time, money, and paperwork to form a corporation, and it is considered as a separate entity although it consists of several people, much like an individual, and is treated as such in the eyes of the law.
The main perk of this structure is that the liability of each shareholder (or member, whether the corporation is stock or nonstock) is limited to the investment they made in the company while protecting their personal assets. That means that in the case of a debt or loss, the private assets of each shareholder are protected by law.
While this structure allows for an infinite number of members or shareholders, it still has certain drawbacks. Unfortunately, a typical corporation’s annual profits are taxed on a corporate level, and then once again as the dividends are shared among the stakeholders, which is known as double taxation, making this structure less appealing for businesses, especially those who are at the very beginning of their professional journey.
On the other hand, since the issue of double taxation is commonly perceived as the main setback of forming a C corporation, as the company’s profit is taxed both on a corporate and on a personal level of each shareholder; you can look for a different solution. This two-layer system causes many businesses to opt for a variation called the S corporation, or the Subchapter Corporation which avoids double taxation while keeping the perk of limited liability.
This calls for each shareholder to file their income taxes individually and report their profits and losses accordingly, which makes it similar to the operation of a typical partnership.
Unlike a C corporation, an S corporation can include no more than one hundred members, who are all individuals and legal citizens of the country of the company’s origin. Provided that all of these conditions are met, then a C corporation can transition into an S corporation.
LLC–Limited Liability Companies
Another variation that protects you from the taxing issue is forming an LLC, also known as a limited liability company. An LLC is a kind of a hybrid partnership, as it holds the same benefits as a corporation, keeping its members protected from liability, and a single taxation layer typical of a partnership or a sole proprietorship.
However, despite this structure’s simplicity in terms of initial formation and setting up, unlike a regular C corp which can last in perpetuity and outlive its members, an LLC needs to be dissolved upon bankruptcy or a member’s passing.
Certain professions, such as medical or legal that need specific licenses to be established, may not be allowed to form a standard LLC, but they can qualify for a variety of this structure also known as the professional limited liability company, or PLLC.
Nowadays, even a single person can form an LLC instead of a sole proprietorship, so having multiple members is not a prerequisite for this structure, making it even more appealing for startups and new business owners. The flexibility of an LLC along with its hybrid blend of limited liability of a corporation along with a partnership’s pass-through income taxation offers plenty of room for growth and development for modern businesses.
However, limited liability should not be construed as complete protection of personal liability. For instance, few business owners realize that they can still be sued personally for the service they have provided, without involving the entire company. A surgeon can be held legally accountable for making a mistake without implicating the whole private practice.
How to Choose Between the Business Structures
While all of these structures are viable options and have their own benefits and downsides, you will need to consider several relevant criteria before settling for your ideal legal solution. Also, bear in mind that you might want to change your business structure after a certain amount of time so you will need to educate yourself on the prerequisites for a business to make the switch.
Learning about running a different business structure might seem like a tedious task, but it’s necessary to establish whether or not you can afford a certain structure, to begin with, and how your long-term goals coincide with the specific legal conditions of your country of residence.
For starters, the sheer price and complexity of record keeping and administration costs can be quite overwhelming for a startup. You will need to assess how much of these necessities your investment can cover, and whether or not you will need to hire a professional bookkeeper if you are not qualified to be one, to keep your business administration in order to a reasonable fee.
In general, all forms of corporations need more financial support regarding their paperwork and ongoing management, unlike the simpler sole proprietorship or a partnership, which makes the latter two a very popular choice for startup companies who are looking to grow their business slowly before diving into the corporate world.
Then again, such a choice involves dealing with insurance policies that are meant to protect your initial investment and cover your losses in case of unexpected events, whether your physical or intellectual goods are at risk.
No matter how tempting and exhilarating it is to devote all of your energy and enthusiasm to creating what is in your hands at this very moment, every successful company can thank its long-term strategic planning for its growth. While your decision will be mostly determined by the factors that seem most appealing and make the most sense right now, you need to assess your business’s future viability and growth potential before you make up your mind.
If you are starting out alone or with a partner, and you are deeply invested in your idea, then the notion of sharing the ownership someday might not be as appealing now, while it might become a necessity or a greater good for your business somewhere down the road. And while the question of your business’s existence after your demise might not be on your mind now, it is yet another determining factor that will form the future direction of your business, and that decision alone can affect your future partnerships, investments as well as your overall success.
Another influencing factor is your perception of other companies’ success so you could be tempted to follow in their legal footsteps and apply the same or similar principles to your internal organization. While this is a reasonable factor to count in, it should be far from determining when it comes to landing on your final choice.
What has worked in the past for your predecessors and competitors might not be a viable solution for your business, and you need to evaluate this possibility while objectively comparing and contrasting their success with your goals, without letting it cloud your judgment.
Level of Flexibility
A commonly overlooked aspect of any business, the flexibility of your business needs to be predetermined by your expectations, legal freedoms as well as your potential partner’s needs. Although most of your operational rules and regulations will be clearly presented in the form of a contract, there are certain unwritten rules that every business needs to consider before setting up.
Rigid ownership will often allow little room for development and growth, while an organization that is too loose and open can, on the other hand, expose your business to certain risks. In the case of a partnership, it is then essential to outline your and your partner’s legal, personal and shared responsibilities, authority, and expectations in a Partnership Agreement. Such a document should contain all the relevant information regarding your investment, and not just financial, but regarding ideas, business opportunities, connections, effort, etc.
Daily duties should also be clearly established, while all the hypothetical situations and possible problems in the future should also be considered beforehand. What would happen to your business should your partner decide to pursue other interests, become disabled, or pass away? How will you handle any potential conflicts and reputation risks and client relationships?
All of these and many more questions will determine the level of flexibility of your company, as well as its potential to outgrow its starting point.
As you’ve seen so far in each structure’s brief overview, every one of them offers a different tax system, which is another significant segment of your business and determines how well it can thrive and become profitable.
While you might start out as a sole proprietorship or in a simple partnership, and you’re far from worrying about double taxation, you should reflect on your business’s future path and how far down the road you might wish to incorporate, and whether or not you would qualify for an S corporation, and what you need to do to ensure this option.
There are numerous options to avoid double taxation and unnecessary losses in the form of federal taxes, so you should carefully map out your company’s long-term steps and fallback options, as well as monitoring your ongoing progress so that you can protect your initial investment, personal assets as well as your future income.
If your business involves expensive equipment, complicated procedures, or even affects the wellbeing of others, your business will be at constant risk of not only lawsuits but from accidents, damage, jeopardizing your reputation, and finally, losing your personal possessions to cover your business losses.
That is the principal reason behind most decisions to incorporate, as both you and your potential partners would like to do their best to avoid or at least limit their personal liability. In the case of a legal issue, losses, or debt, then your private property and assets are protected by law, which is a major element for most high-risk businesses, as well as those that have much to lose while working with large contracts.
Most of these complex decisions will be largely influenced by your field of work so not even the best and most successful existing businesses can be used as a bulletproof strategy to ensure your success. Even the greatest among modern businesses such as Google might have had humble beginnings — somewhere in a dorm room and stuck in a basement behind a less than adequate computer, but with a brilliant idea, plenty of determination, and hard work to back up their dream and ingenuity.
If there’s anything you can learn from their success, it is that you need to let go of the desire to follow in their footsteps, but create your path, including the very essentials such as the legal structure of your business, to allow your vision to thrive and succeed.