Small businesses are the backbone of the American economy, responsible for more than 44 percent of the country’s economic activity and two-thirds of all new jobs. Starting and growing a small business requires fortitude, flexibility, and good ideas about what your customers want and how to deliver it.
Building a viable business requires a solid foundation to be in place from the outset, starting with the initial business idea for a product or service, a business plan for financing, producing, and marketing that product or service, and a long-term strategy for growth and expansion.
Another aspect of business start-up is what type of entity (ownership structure) best suits your business. The most common types are sole proprietorship, partnership, corporation, and limited liability company (LLC). Each type has its advantages and disadvantages depending on your situation.
Sole Proprietorships—This is where you’ll find freelancers, consultants, and other solo professionals who are the sole owners/operators of their businesses—at least when they first start out. Sole Proprietorships are popular because they’re easy to start and administer. There’s no need to file with the state, though local jurisdictions may require certain permits (you’ll have to check with your town or city). There are also few, if any, formal paperwork obligations, and taxes for business income flow through your personal returns. That said, business debts and liabilities are the personal responsibility of the sole proprietor, which means if your business gets sued, your personal assets could be in jeopardy. Eventually, most sole proprietors make the transition to an LLC or corporation to gain liability protections.
General Partnerships & Limited Partnerships—Think of a General Partnership (GP) as a Sole Proprietorship for two or more owners who actively manage a business and share in the profits and losses. As with Sole Proprietorships, there’s no need to register with the state, formal paperwork is practically non-existent, and business income and loss is filed with personal returns. Similar to sole proprietors, personal and business liabilities can overlap, with one important difference—each partner may be legally responsible for the actions of the other partners. Also, without strong working agreements in place that delineate each partner’s responsibilities and obligations, relationships can become strained, leading to disputes that often hamstring a business or end friendships.
Another form of partnership is called a Limited Partnership (LP), which is a registered business entity that brings with it requisite paperwork and record-keeping with the state. LPs are formed in addition to a GPs, with the general partners maintaining day-to-day management of the business and limited partners acting as investors without any day-to-day involvement. As investors without an active role in the business, they do not assume personal liability. LPs are often a way to bring in outside investors. A word of caution: if LPs do play too much of an active role, they can take on personal liability, just like a general partner.
Corporations—Corporations are business entities that register with the state and that means they’re subject to certain business formalities like electing officers and lots of record-keeping. Typically, corporations are established as either a “C” corporation or an “S” corporation.
With both C and S corporations, if someone sues the business, only the corporation’s business assets are in jeopardy, not the owner’s personal assets. In a C corporation, taxes are paid through a corporate tax return with shareholders paying taxes on dividends via their personal returns. With an S corporation, taxes are handled similar to Sole Proprietorships or General Partnerships. The choice between whether to file as a C or S corporation usually comes down to how owners want taxes and finances handled.
LLCs—More than 80% of small businesses in the United States are LLCs. This type of entity combines the simplicity of Sole Proprietorships and General Partnerships with the liability protection of being a corporation.
LLCs also offer flexibility in how taxes are filed and how owners get paid. For these reasons, setting a business up as an LLC is often the ideal choice for owners looking for less paperwork and business formality, while enjoying the liability protections of a corporation.
Making the Right Choice for Your Business
As you can see, there are numerous reasons why a certain business entity might be right or wrong for your situation. The experienced business attorneys at Shoup Legal can help you decide which type of business formation is best for your company and your goals.
They’ll help you weight factors such as . . .
- Anticipated revenue and profits
- Management and ownership structure
- License and permit requirements
- Whether you intend to hire employees
- Whether you intend to purchase real estate or other assets
- The role of investors (if any) in your company.
Contact us at (951) 445-4114 or email us at [email protected] today to discuss your unique business situation.