Starting a business requires aspiring entrepreneurs to make hundreds of different decisions before opening their doors to customers. One of the most important decisions is choosing the right legal structure for your company. The way you choose to organize will affect your taxes, personal liability exposure, and fundraising options.
Sole proprietorship is the most common arrangement for people who are self-employed. This structure is a popular choice because it is the easiest to set up and does not require any submissions to the state. However, one of the greatest disadvantages of a sole proprietorship is that the entity does not exist separate from the owners. As a result, the owner is personally liable for all financial obligations and damages resulting from lawsuits filed against the company. Another disadvantage is the difficulty of raising capital. Banks are reluctant to provide loans to individuals, leaving owners to rely on home equity loans or borrowing from families.
For companies with more than one owner, a partnership may be a good arrangement. Each partner contributes capital, labor or expertise to generate profits. The partners share profits, but like sole proprietorships, 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 a general partner who makes decisions and bears the risk and a limited partner who has no control over operations in exchange for a reduction in responsibility. The tax treatment is one of the main reasons this arrangement was chosen. Profits and losses are passed on to the respective partners.
A Limited Liability Company, or LLC, is a type of structure that is becoming very popular. This structure creates an entity separate from the owners. As a result, the owner is not responsible for the debt or valuation of the business. Unlike a limited partnership, all members are free to participate in management and enjoy protection from personal liability. LLCs also enjoy bypassing taxation. However, the tax rules for these structures are complex. The amount of paperwork is a major hurdle, and members must submit articles of organization to the Secretary of State or sign an operating agreement.
The right structure for your business depends on a number of different factors that are unique to your company. For example, a small boutique selling handmade cat collars is obviously less risky and probably less profitable than a company that provides window washing services for high-rise office buildings. Prospective entrepreneurs are advised to contact their lawyer or accountant to discuss the tax consequences and liabilities of the different entities. A number of free or low-cost resources to help you make decisions are available from your local chamber of commerce, the Small Business Administration, or volunteers in the Service Corps of Retired Executives.
Choosing an organization for your business is one of the most important decisions you and your partners will make. Research all available options and seek advice from experienced professionals before making your choice.