Deciding Which Business Entity is Right for You
Starting a business can be confusing, especially if you are unfamiliar with the type of entity you need. The short story no one tells you: What is good for one person, may not be good for you. Just because you see many people glorify certain entities, does mean that entity is best for you and your goals. This blog will take you through the list of entities: Sole Proprietorship, Corporations, Partnerships, and Limited Liability Companies (LLC's). By the end of the blog, we hope that you understand these entities better and leave with a solid foundation of knowledge regarding which entity is best for you.
Sole Proprietorship
A sole proprietorship is the simplest of all legal entities. It ties the individual to the business they operate. They are treated as one entity for tax purposes. This person is paid for the services they perform without taxation. They are responsible for paying their own taxes on income.
This structure is common among service providers such as barbers or carpenters, because this type of entity allows a person to perform work without being an employee of someone else.
Because they are not separated from the business they perform, the owner is personally liable for any damages incurred. This means their personal assets are at risk in the event legal claims are made: If a customer files a lawsuit because of a faulty job, you are personally held responsible.
Limited Liability Company (LLC)
A LLC brings separating to an individual and the business operations they conduct. In other words, separate tax returns are required. The business that is operated must file it's taxes separately from the business owner. This means in the event that lawsuits are filed against the business, the owner and all personal assets are protected.
LLC's are a common structure for service providers like lawyers and consultants. They are also a popular choice among smaller restaurants and stores. They are owned by the member(s) developing the business.
Partnerships
Partnerships consist of the same standards as LLC's, the difference is the amount of liability that is taken among the individuals. A Partnership is the plural form of Sole Proprietorship. Partnerships require individuals to possess liability. in other words, all business debts and liens fall on the individuals of the partnership.
The owners of partnerships usually only pay individual income tax, but are deemed self employed and must pay taxes on revenue earned. A partnership agreement between members is highly recommended.
Corporation
A corporation is an entity that contains shareholders. It does not tie an individual to the business they operate; and, and they are treated as two separate entities for tax purposes. In other words, you will file taxes on your business separately, and not with your individual tax return.
This structure allows the company to be owned by shareholders. Shareholders are those that invest in a company to see a return on investment. This includes you as a business owner, but also includes investors who might see potential for your company to grow with a monetary investment. With a corporation, you have access to investment capital through selling shares of your company. Shareholders are also entitled to revenue produced as a result of their investment, while still allowing the the control of the company to be that of the board members (a board may consist of a single person in the beginning stages of formation).
Because this structure is separated from the individual, personal assets are no longer a risk. Any lawsuits that are produced are taken on by the company and not the individual shareholders.
There are two different types of corporations: There is an S corp and a C corp. They both have their benefits and challenges. For example, S corps allow only one type of stock to be sold, whereas a C corp allows multiple. A C corp is double taxed: They are taxed as a corporation and shareholders are taxed personally; while, a C corp is not taxed as a corporation, but shareholders are taxed personally. An S corp only allows 100 shares to be sold, while a C corp does not have a limit.
If you are an individual considering a corporation as a business structure, it might be wise to choose S Corp in the beginning. You can change your entity to a C corp later, as you scale and grow.
Which Entity is Best?
Determining which entity to choose requires knowing the needs of the individual operating the entity, and the needs of the company. Consider the amount of liability and taxation required. Building business credit and obtaining large lines of credit are more likely to be obtained through an LLC or Corporation, when individual and business expenses are separated.
Let's Turn This Knowledge Into Power
Did this article help you decide which entity is best for you? Let your next steps towards building your startup business be clear and insightful. See our "Business Fundamental Course" to learn how to start and structure your entity for long-term success.