One of the most important decisions an entrepreneur must make is legally forming their business. Many people think that by having a great business plan, and an attractive name, they can jump into the market and start selling, but that is not the case.
The first thing you must do is register your business. Regardless of the type of business you are running, you must formally register it as a legal entity for tax, liability, and organizational purposes.
There are several options to choose from, and the structure you choose will have a big impact on how taxes are paid, financial liability, and how you are classified by the IRS and state auditors.
Here are the most common types of business structures:
- Sole Proprietorship
- Limited Liability Company (LLC)
To find the most suitable option, you should understand the main characteristics of each, their pros and cons, and how these factors impact your business needs.
Sole Proprietorship: This refers to a self-employed individual who runs their own business (but may also employ other staff). A sole proprietor is solely responsible for the business and its debts: The business and owner are practically one.
- Once you have paid your taxes, you get to keep all trading profits.
- You have full control of the business, and you make all the decisions.
- Your business data is kept private.
- You are solely responsible for business losses.
- The pressure for a business to succeed is placed on the shoulders of one individual.
Partnership: This structure is where two or more people form a business together. All business partners share the business responsibilities. Profits earned are split between each partner, and they are individually responsible for paying their share of taxes.
- The more partners, the greater the chance of profit and the easier it is to maintain the business financially.
- A partnership allows the tasks and responsibilities of the business to be assigned to each partner based on his or her skill set, which takes the stress off of one person.
- Business problem-solving and decision-making can be simplified since there are various opinions.
- The possibility of conflict increases when partners disagree on how the business is run.
- Tax laws state that each partner is responsible for their own taxes, just like a sole proprietor. In addition, if a partnership generates a certain level of profit, the partners may face paying more than they would in a limited partnership.
Limited Liability Company (LLC): A limited liability company is a business owned by one or more people referred to as Members. The owner(s) are not personally liable for debts that the company cannot pay. Their liability is limited to the amount of money invested in the company. The partners’Members profit shares and liabilities are determined by an LLP agreement.
- The liability of the firm is not reduced to one person, including financial matters and business liabilities.
- The number of business partners is unlimited.
- Depending on whether the LLC is a single or multi member LLC, are not legally required to consult with other partners whenthe making business decisions, which can cause conflictprocess scan vary in many ways.
Corporation: This is a legal entity that is separate from its owners. Unlike a sole proprietor/partnership, all company finances are kept separate from personal finances. After taxes are paid, the profits are available for distribution to shareholders as dividends.
- You have the option of offering shares in the company to your employees, which motivates them and gives them a say in how the business is run.
- Bookkeeping and accounting for a corporation are more complex, requiring you to keep accurate records as you go along and present a variety of data each year.
- Certain information about the company, its directors, and shareholders is available to the public.
As you can see, there is no “one size fits all” when choosing a business structure. Ideally, you should consult with legal experts to help you identify the one that best suits you and your venture.