Choosing a legal structure for your business
Starting a business requires would-be 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 enterprise. How you choose to organize will affect your taxes, personal liability exposure, and fundraising opportunities.
Sole traders are the most common arrangement for people who work alone. This structure is a popular choice because it is the easiest to organize and does not require any paperwork in the state. However, one of the biggest disadvantages of a sole proprietorship is that the legal entity does not exist separately from the owner. Therefore, the owner is personally liable for all financial liabilities and damages resulting from lawsuits filed against the company. Another disadvantage is that it can be difficult to raise capital. Banks are reluctant to lend to sole proprietors, leaving owners to rely on home equity loans or loans from family.
For businesses with more than one owner, a partnership can be a good arrangement. Each partner contributes capital, labor or expertise to make a profit. Partners share in the profits, but like 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 the decisions and bear the risks, and limited partners with no control over operations in exchange for reduced liability. Tax treatment is one of the main reasons for choosing this arrangement. Profits and losses are passed on to the individual partners.
Limited Liability Companies, or LLCs, are a type of structure that is becoming very popular. This structure creates an entity separate from the owners. As a result, the owners are not liable for any debts or judgments against the venture. Unlike a limited partnership, all members are free to participate in management and enjoy personal liability protection. LLCs also enjoy pass-through taxation. However, the tax rules for these structures are complex. The amount of paperwork is a huge 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 enterprise. For example, a small boutique selling handmade cat collars will obviously have less risk and perhaps less revenue than a company that provides window cleaning services to high-rise office buildings. Prospective entrepreneurs are advised to contact their attorney or accountant to discuss the taxation and liability implications of the various entities. A number of free or low-cost resources to help you decide are available from your local Chamber of Commerce, Small Business Administration, or volunteers from the Retired Executive Service Corps.
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.
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