As a startup founder, one of your biggest concerns is determining the ideal legal structure for your business. Choosing the right one is critical to your operations. It can have a significant impact on the different aspects of your business, such as:
· The costs of establishing a specific entity
· The number of owners or investors your startup has
· The amount of tax you have to settle
· The number of your deductions and earnings
· The personal and professional liabilities you can have
However, choosing the right one for your startup can be complicated and overwhelming, considering the amount of information you have to digest and understand. Primarily, there are four forms of business structures: sole proprietorship, partnership, limited liability company (LLC), and corporation.
So which business setup is it going to be for your venture? Is it sole proprietorship vs. partnership or LLC vs Inc?
Choosing the ideal legal entity for your startup depends on who will decide and your knowledge about legal structures. The decision-making team should include an attorney, an accountant, and other experts for the advice that will pave the way for your success.
Knowing and understanding the various business structures is critical in helping you choose the right one for your startup. This article discusses the different types of business structures and how to choose the right one. Read on to learn more about setting up the right type of business!
Sole Proprietorship
A sole proprietorship is a business owned and managed by a single individual—hence the name. It’s also the simplest business structure you can apply for your business and usually evolves to a much larger entity as the business grows.
This business structure is ideal for:
· Someone who wants to make their hobby a source of income.
· A local business that depends on the supply and demand of its surroundings.
· A business operating during peak seasons, such as holidays.
Here are some advantages of a startup under the sole rule:
· Simplicity: Once you sell a product or service, you’re considered the sole proprietor. You don’t have to register and prepare complicated documents.
· Cost-Effective: Sole proprietors don’t need to file process documents, which can be expensive, in order to run.
· Small Taxes: Sole proprietors aren’t taxed heavily like other entities aside from your personal income taxes based on your profits.
On the other hand, here are a couple of disadvantages to keep in mind:
· Limited Room For Growth: Sole proprietorship doesn’t scale up as the business grows. It has to be converted to maximize the growth potential of a business.
· Forget Tax Benefits: Sole proprietors aren’t entitled to tax benefits for higher earners and taxpayers, such as corporations and LLCs.
Partnership
Businesses under partnerships are similar to sole proprietorships, but they’re owned and managed by two individuals. Additionally, partnerships are classified into two types: general and limited. General partnerships split every aspect of a business between the two owners, such as business operations, incomes, liabilities, etc. Limited partnerships are usually hands-off but still help grow the business.
Here are some advantages of startups under partnerships and LLP structures:
· Reduced Financial Burden: Because there are two owners in a partnership, the financial burden will also be separated into two. For example, low capital investments are enough to run the business.
· Maximum Collaboration: As they say, two heads are better than one. Partnerships open the doors to endless possibilities, idea creation, and decision-making to make the business succeed.
· Shared Chores: In partnerships, the responsibility of one is the responsibility of the other. Both have to make crucial decisions for the betterment of the company.
On the other hand, here are some disadvantages of partner-owned businesses:
· Shared Liabilities: The mistake of one is the mistake of the other, so be very careful when making decisions under this type of business entity.
· Reduced Personal Profit: Since all earnings are shared, all your profits will be divided into two equal portions or, depending on the agreement, if there are any.
Limited Liability Corporation
A limited liability corporation (LLC) is a state-registered business established through the submission of a formal document referred to as articles of organization. The primary purpose of establishing LLC-type companies is to protect your personal assets from business liabilities, such as debts and taxes.
Here are the advantages of establishing an LLC or PLC:
· Personal Asset Protection: In LLC, if your business owes unpaid debts, your personal assets, such as cars and real estate properties, won’t be used to settle them.
· Member-Owned: Members are considered owners of the LLC. This promotes a culture of teamwork and positive collaboration between different people with different personalities, paving the way for the company’s success.
· Flexible Operations: Businesses under LLC have a better organizational chart and structure compared to partnerships and sole proprietorships. Despite that, you can still customize your operations however you prefer.
· Flexible Taxes: The taxes of a business under an LLC are separated from its owners. The taxes of its owners depend on the income they receive from the business, not the total profit of the business. The owners of an LLC are required to Apply for a Federal Tax ID that they will use to report and file their taxes with the IRS. This process can be tough and that is why many owners choose to work with a registered agent to help them file their taxes correctly.
On the other hand, here is a disadvantage of running an LLC startup company:
· Cold To Investors: LLCs are not the type of business entity you should establish if you are looking for investors, venture capitalists, and more to grow your business. Why? Because most of them only invest in corporations and for them, LLCs are very unpredictable by comparison. Limited Liability Companies are often considered too small and new to consider investing in.
Corporation
A corporation is another state-registered business, but instead of filing articles of organization, you need to file articles of incorporation. Running one can be complicated, depending on how many owners there are in a business.
Establishing a corporation is ideal for LLCs who want to expand their structure and for startups funded by investors.
Here are some advantages of establishing a startup corporation:
· Investor-Friendly: Corporations appeal to most investors because they’re predictable compared to LLCs, allowing them to receive returns on their investments without any hassle.
· Tax Benefits: Corporations enjoy the benefits of different corporate tax laws, especially when certain operations help stabilize the economy—for example, hiring employees.
Here are some disadvantages of running a startup corporation:
· Stern Operations: Corporations have a lot of things to execute, such as shareholders’ meetings, estimated tax payments, and more. These may be ideal for those startups looking for investors, but they can be costly to startup founders.
· Risky: A corporation is the riskiest among business structures in terms of contracts, funding, and numerous requirements. This makes it difficult and expensive to dissolve and establish.
Factors To Consider When Choosing A Business Structure
Choosing the proper business structure is crucial as you start your business. Your business structure has legal, operational, and financial implications. Aside from the pros and cons, there are other factors that you must consider to choose the most suitable business structure for your startup. These include the following:
· Asset Protection
Keeping your personal assets separate from your business protects them in case your business is sued by parties you failed to pay. If there’s a possibility of incurring debts you wouldn’t be able to settle in the future, you should consider establishing an LLC or a corporation. Sole proprietorships and partnerships won’t be able to protect your personal assets from creditors who go after them.
· Complexity
Complex entities include LLCs and corporations. They must be registered and must adhere to certain requirements. For example, a corporation is required to hold an annual shareholder’s meeting. Also, managing such entities can be complicated. Therefore, professionals, such as accountants, have to be considered.
· Tax Flexibility
Pass-through entities, such as sole proprietorships and LLCs, are only taxed when the profits are passed through the owners as individual income. When the tax season arrives, owners will be taxed as individual returns. However, a C corporation, a type of corporation, taxes both the business and owners who receive their dividends.
· Cost
Establishing an entity can be expensive, depending on the complexity of the structure. The most expensive entities are LLCs and corporations, which need larger capital to form. If you don’t have much to lose, your best option is to establish a startup under sole proprietorship or partnership.
Final Words On Startup Structures
Choosing the right business structure is crucial to any startup. Many operations, especially financial responsibilities, will be affected by your choice. As you can see, each type of entity serves a different function and purpose. So, carefully analyze your needs, remember the factors you must consider, and match them to the above pros and cons.
