Starting a business requires prospective entrepreneurs to make hundreds of different decisions before opening their doors to customers. One of the most important decisions is selecting the right legal structure for your company. How you choose to organize will affect your taxes, personal liability exposure, and fundraising options.
Sole proprietorships are the most common arrangement for people who work alone. This structure is a popular option because it is the easiest to organize and does not require any filing with the state. However, one of the biggest disadvantages of the sole proprietorship is that the entity does not exist apart from the owner. Consequently, the owner is personally responsible for all financial obligations and damages resulting from lawsuits brought against the company. Another disadvantage is that it can be difficult to raise capital. Banks are reluctant to lend to individual businesses, leaving owners to rely on home equity loans or family loans.
For businesses with more than one owner, a partnership might be a good arrangement. Each partner contributes capital, labor or experience to make a profit. The partners share in the profits, but as a sole proprietorship, they are also personally liable for debts and damages. One way partners can reduce personal exposure is by forming a limited partnership. This form consists of general partners who make decisions and bear the risks and limited partners with no control over the operations in exchange for reduced liability. Tax treatment is one of the main reasons this arrangement is selected. Profits and losses are transferred to the individual partners.
Limited Liability Companies, or LLCs, are a type of structure that is becoming very popular. This structure creates a separate entity from the owners. As a result, the owners are not responsible for any debts or judgments against the company. Unlike a limited company, all members are free to participate in management and enjoy protection against personal liability. LLCs also enjoy going through taxes. However, the tax rules for these structures are complicated. The amount of paperwork is a big hurdle, and members must file articles of organization with the Secretary of State or sign an operating agreement.
The right structure for your business depends on a number of different factors unique to your company. For example, a small boutique that sells handmade cat collars will obviously have less risk and perhaps less revenue than a business that provides window washing services to high-rise office buildings. Prospective entrepreneurs are encouraged to contact their attorney or accountant to discuss the tax and liability consequences of the different entities. A number of free or low-cost resources to help you make your decision are available from your local chamber of commerce, the Small Business Administration, or Retired Executive Service Corps volunteers.
Selecting the organization for your business is one of the most important decisions you and your partners will make. Research all available options and seek the advice of experienced professionals before making your selection.