One of the most critical decisions you’ll make when starting a new business or venture is the structure of your company, which will have implications on the company’s entire life cycle. Your business structure affects how much your business will pay in taxes, your ability to raise capital, and your personal liability. When registering your business with the state, you will have to choose a structure, which will determine the licenses and permits that will be needed to establish your business. The business structure you choose will also have ongoing effects, including potential for financial growth, mergers, and acquisitions. Therefore, having an in-depth understanding of each type of business form is critical. To help you make the best decision for your business, we will walk you through each of the four main ways to structure a business depending on your needs.
There are four main types of business structures, and each one has its advantages and disadvantages. Sometimes business owners may start off using one type of business form but change to a different form as it grows. Having an attorney advise you from the beginning is critical to meet your current and potential growth needs.
A sole proprietorship is the simplest and least expensive type of business to form; there are little to no incorporation documents to file or business notices to run. A sole proprietorship has only one owner who is responsible for and in control of all company’s profits and debts. This means that since you and your business are a single entity, you may be eligible for certain business tax deductions, such as health insurance deductions. This also means that if you so desire, you can easily dissolve your business at any time with no formal paperwork.
However, as a sole proprietorship, you are left vulnerable to unlimited personal liability, meaning that there is no separation between personal and professional or business assets. Being personally liable also limits your ability to take on business debt and potential growth. Although this business structure gives you total control and is the least expensive and most autonomous, a sole proprietorship also has limited potential for growth and leaves the sole owner unprotected from business debts and liabilities. If you are starting a business, in certain circumstances, this may be the best option, but an experienced business attorney can advise you if choosing this type of business formation will leave you open to too many risks.
A partnership is the one of the simplest business structures to form for two or more individuals to own an entity together. There are three common partnerships: a general partnership, a limited partnership (LP), and a limited liability partnership (LLP).
A general partnership is when the parties have equal ownership, while in a limited partnership, an individual(s) retains control over the business and the other(s) receive(s) a portion of the profits but does not maintain control. The partner(s) without limited liability must also pay self-employment taxes. Keep in mind that while the limited partner(s) may not have control over the business, they will share equally in both profits and losses, which means that they will also share equally in debt and other liabilities. A limited liability partnership protects each partner from debts and certain liabilities against the partnership so that the individual partners won’t be responsible for the actions of their partners.
As a business structure, a partnership allows for more borrowing potential, as multiple lines of credit can be considered to take on business debts. However, it is imperative that you have an experienced attorney review your partnership agreement to make sure that rights and obligations are clearly defined, rules of engagement are determined, and your investment is protected within the partnership agreement.
Another critical aspect of any partnership is initially setting out what will happen if and when the partnership breaks up or irreconcilable differences arise between the partners. Buy-sell and dissolution provisions are of the utmost importance when setting up any partnership. An experienced business attorney knows the various forms and implications of such provisions will help partnership agreements avoid future litigation and the potential for costly business divorces.
A limited liability company (LLC) is a hybrid structure that takes advantage of both corporate and private business structures. This is the most common business structure among small businesses. LLCs do protect against personal liability in most instances. For example, your personal assets may not be at risk if your LLC were to go bankrupt or be sued. However, individual members of an LLC are considered self-employed and must pay taxes to government programs including Medicare and Social Security.
LLCs can have multiple owners (members) and, similar to a limited liability partnership, each partner does not have to take on equal ownership, nor share equally in profits or losses. Additionally, members can protect their own liability within the LLC; counsel should be attained to create the necessary framework to protect you from liability. Additionally, requirements of setting up an LLC vary by state, and using an attorney when filing with the Secretary of State will help avoid common mistakes. It is strongly advised to have an attorney prepare and review additional legal documents, such as the operating and partnership agreements, to protect your partnership interests and assets.
A corporation is a more complicated and highly structured legal entity that is separate from its owners. Corporations can make a profit, be taxed, and be sued separately from the owners. This means that if one owner sells his or her shares of the company, the corporation can continue doing business relatively undisturbed. Similarly, because personal assets and the liability are separate, if the corporation is sued, there may be no personal liability. Additionally, corporations have an advantage in acquiring debt, raising funds, etc. in that they can sell their shares in stock. This can be good for a business that eventually plans to go public and share stocks.
Business formations are also understood as a tax status. Therefore, it is possible to combine different structures; for example, an LLC can be taxed as an S Corporation, which is often the best and most often recommended business structure. If you are considering one of these nonstandard structures, you should seek legal advice.TIP
For new businesses that fall into these categories, it can be difficult to decide which legal structure to choose. Some things that must be considered when making the decision are financial needs, risks associated with each structure, and their ability for growth. While not impossible, it can be difficult, costly, and time-consuming to change your legal structure after you’ve registered your business. Therefore, careful analysis in the early stages of forming your business should be made not only as to where you are now, but how you want your business to grow in the future.
Determining the right structure is not a “one size fits all” model. It should be custom to you so that you can orchestrate and plan your liability exposure and risk, protect your personal assets, minimize tax liability, and plan an exit strategy, which may avoid future partnership disputes and lawsuits by and against the partners. Buy-sell provisions are one area where a tailored solution at the outset is key for any partnership or LLC operating agreement. Having a well-drafted succession plan in case of death can save valuable time and costly litigation. For this and other custom business structures, it is important to find an attorney who is willing to take the time that is necessary to thoroughly evaluate your current business model and future needs as well. If you need help determining what business structure will best suit your needs or need an experienced attorney to help you structure and protect your business and personal assets, obligations, and liabilities, contact us at Steinberg Law.