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CHOOSING THE BUSINESS STRUCTURE FOR YOU
Deciding your business structure is still one major decision to be made before starting any business. Deciding on the type of structure that will be best for you, and your new business, is a major decision and you need to spend a bit of time on getting it right. How you choose and what you choose depends on a host of factors including both personal and legal implications. Here are some of the factors to look at that can have an impact on your choice of business structure. Remember them when you are looking at the possible choices. - Type of business. Will your business be of low or high risk in regard to liability?
- What is your personal tax situation; have you lots of valuable personal assets?
- Will you need to raise money for expansion? Will it be through a loan or via stock issues?
- Has your business got the potential for large growth?
All of these factors will have a bearing on the type of business structure that will be best for you. Always consult with your lawyer and accountant before you make your final decision. You could have to live with it for a long time! Before any decision can be made you should be aware of the different types of business entities that are available to choose from in the U.S.A. The majority of other countries have similar or variations of these forms, but you will need to check on the specific for your country. Types of legal business structures There are five basic forms of business that are available, so lets have a look at each one to help you determine the best form for your business. - Sole Proprietorship
The simplest of all and if you intend to work alone, might be right for you. Advantages - Simple to form and operate. Owner retains all controls.
- Filing taxes is easy as all profits and losses of the business are filed with your individual income tax return (IRS 1040) together with an attached schedule C form.
- As all business monies are handled by you, bookkeeping is simple. Keep your business and private finances separate however.
- Virtually no start up costs such as lawyers, special forms, etc.
Disadvantages - The biggest and most frightening disadvantage is that you are personally liable and responsible for all the debts and liabilities of the business. There is no separation of business and personal assets, all can be seized to meet any legal claim against you.
- It can be difficult to raise capital for a sole proprietorship as banks are not keen to lend money to them.
- As there are no legal requirements for financial statements or company minutes, you can be tempted to ignore these controls. This is often fatal; all businesses need proper financial accountability.
- When the owner dies the business ends.
Forming a sole proprietorship business structure is easy; simply do nothing and the IRS will consider your business a sole proprietorship.
- Partnership
When ever you have more than one individual starting a business together, a partnership can be considered as an appropriate structure. Let me just mention that there are two forms of partnership: general partnership and limited partnerships. A general partnership is where two or more people manage the company, own all the assets and are liable for all debts. The limited partnership contains both general partners, who in effect own the business and manage it and limited partners who are basically investors and have no control or vote in the company. Advantages - The big advantage is that there is no double taxation. Tax is not paid on partnership income as all profits and losses are passed onto the partners and so reported on their individual tax forms.
- Partnerships can work extremely well if structured well, to do this you must consult your lawyer. On the other hand partnerships can destroy themselves very quickly if partners fall out with each other.
Disadvantages - Like sole proprietorships, general partners are personally liable for all debt in this form of business structure.
- In many cases one partner’s actions, borrowings or decisions will be binding to all the partners.
- Can be a lot more expensive to set up a good partnership with the necessary partnership agreements.
- Unless specifically covered in the partnership agreement, the partnership dissolves on the withdrawal or death of any
- The C Corporation
This being the standard as opposed to the S Corporation. A C Corporation business pays taxes on all its net profit. Advantages - No personal liability for the owners for any losses.
- Corporations can find it easier to raise capital through loans or by selling stock.
- Adding investors, owners or the transferring of ownership is easy.
- No death, withdrawal of a shareholder or an owner, can affect the business.
Disadvantages - It costs a lot more to start and maintain a corporation business structure.
- A lot more paperwork is needed to meet all the regulations relating to corporations.
- Payment of double taxation on the corporations net profits and dividends have to be met.
- Meeting all the state and federal agencies rules and regulations can be a pain.
Unless your business is a large employer, there is little advantage in becoming a C Corporation.
- The S Corporation
With its better tax benefits and limited liability protection, the S Corporation can be a very attractive business structure for small businesses. Advantages - All profits and losses are reported on the shareholders personal tax returns. So no double taxation. No corporate tax.
- Shareholders are not personally liable for any debts of the business.
- Can have up to 100 shareholders and so can attract more capital.
- Survives the death of shareholders, owners or partners.
Disadvantages - As for the C Corporation, the S is a lot more expensive to set up and maintain.
- All shareholders pay tax on their share of the profits, even if the profits are retained and not distributed.
- You are bound to use the calendar year, without exception, as your fiscal year.
- Once again meeting all the state and federal agencies requirements can be tedious.
This ownership structure, together with that of the limited liability company (LLC) are the two most popular for small business. You can find more on partnerships and corporations by visiting the IRS Web site
here.
- Limited Liability Company (LLC)
A popular form of business structure among small businesses. This hybrid structure gives business people the benefit of liability protection with no double taxation. Advantages - Gives one many of the benefits of a partnership as well as those of a sole proprietorship. Tax is passed on to the individual.
- The shareholding owners are protected from the debts and liabilities of the business by limited liability.
- There is no limit to the number of members of the business.
- The necessity for reporting is reduced.
Disadvantages - Taxes on LLC’s can vary from state to state.
- The continuity of the business following death or withdrawal will depend on local states laws.
- At some time, if you ever wish to take your business public, a C or S corporation structure might be preferable.
In general a LLC business structure is probably one of the best from a tax point of view for small businesses.
Your choice Now that you have some idea of the type of business structure that is going to suit your business, here are my recommendations. - Apart from the selection of a sole proprietorship, all other business types’ decisions will benefit from the input of your lawyer and or accountant.
- Choose wisely, based on the present and long term futures needs of the business. You can change structure as your business grows but each change will cost you time and money.
- Any small business registration is best left to your lawyer.
- Take a look at your business from time to time. Is it still being operated under the most suitable structure or have circumstances and laws changed, necessitating a new or better structure?
Always make sure that you have in place the business structure that will give you and your business the best chance of success.
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