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5 Main Considerations When Choosing a Business Structure

Launching a new business is an exciting venture, but it’s important not to lose sight of important details amid all the eagerness and anticipation of getting the company up and running. As you prepare to build your company, you’ll need to make several important decisions. Selecting your business structure will be a crucial business decision you’ll need to make once you get the proverbial ball rolling. You’ll want to choose carefully since the structure you choose directly impacts your company’s finances, taxes, flexibility, and can have potential legal implications.

Most Common Business Structure

Selecting the right structure is one of the primary decisions you’ll need to make early on, long before you open your doors. As you prepare to launch your new company, it’s worthwhile to: 

  • Familiarize yourself with the most common business structures 
  • Understand the intricacies of each option 
  • Select the structure that makes the most sense for you 

Let’s take a look at the most common business structures. 

Sole Proprietorship 

business-structure

Sole proprietorships are the simplest business structure. You own and control all aspects of the company and are responsible for all its business functions. As the owner of this business type, you are entitled to all of the profits. However, this means you’re also responsible for the company’s debts, liabilities, and losses, along with any potential lawsuits. This means your personal assets are at risk since no separate legal entity is in place with a sole proprietorship. 

Partnership 

General partnerships are a lot like sole proprietorships except the business is run by two or more parties. Each partner shares in both profits and losses and is equally responsible for any legal liabilities that may emerge. Even if only one partner does wrongdoing, all partners will carry responsibility. However, there are ways partners can protect themselves by entering limited partnerships and limited liability partnerships. 

Corporation 

Corporations are established as a separate legal entity from its owners. Essentially, a corporation acquires the same rights and responsibilities as an individual. Any of the owners’ assets, debts, or other personal legal and financial responsibilities are separate from the company. Owners (shareholders) of corporations acquire profits through dividends and stock appreciation. When forming a corporation, it’s important to understand the differences between forming a C Corp vs. an S Corp so you make the right choice. 

Limited Liability Corporation (LLC) 

LLCs are a type of flexible business structure utilizing components of both partnerships and corporations. A significant benefit to LLCs is the owners can separate their personal and business assets, relieving them from personally being responsible for debts, liabilities, and legal proceedings the business faces. Owners of an LLC are referred to as “members” and anyone, from a sole proprietor to a group of business owners, can form an LLC. 

Now that you know your primary structure options, let’s look at five main considerations you should think about when choosing a business structure. 

  1. Administrative Responsibilities

One of the first questions you should ask yourself is how complex you want your business’s administrative responsibilities to be. 

Structures, such as sole proprietorships and partnerships, are fairly easy to establish and maintain. You’ll only have to complete minimal paperwork, and you won’t have the same compliance requirements LLCs and corporations need to adhere to. 

On the other hand, LLCs and corporations have layers of administrative complexities. Although, many significant benefits, including credibility and legal protections, come with this extra work. For many, in the long run, these advantages will far outweigh any drawbacks. 

  1. Upstart and Maintenance Costs

Getting ready to launch a startup business involves costs. Your access to funding is another crucial consideration, and you’ll need to factor in how much it’ll cost you to launch. 

While sole proprietorships and partnerships are the least expensive, you could lose out on other potential cost-saving opportunities down the road. Corporations and LLCs involve paying fees to form the legal entity, along with typically incurring attorney fees. Fees to form corporations and LLCs will vary by state. 

For instance, it’s cheapest to form an LLC in Kentucky, where it costs $40 with a $15 fee each subsequent year. Whereas Massachusetts charges $500 to form an LLC, and the annual fee to renew subsequent years is costlier than other states. California charges $70 to start but charges a whopping $800 franchise tax each year, and then, there are states like Texas that charge a costly $300 fee but do not charge future annual fees to maintain an LLC. 

Ultimately, in some states, it’s more expensive to register an LLC upfront but cheaper in the long run, so along with checking the initial fees in your state, see how much it charges after the first year. 

  1. What Are Your Tax Considerations?

Paying taxes is another factor to consider. The business structure you choose will directly affect your tax obligations. Additionally, your chosen structure will dictate the rules and regulations you’ll need to follow to comply with business tax laws. 

As the owner of a sole proprietorship or partnership, you’ll have to claim the company’s income as your own. It does simplify the tax process since only one return needs to be filed, but you also can lose out on the tax benefits LLCs and corporations qualify to receive. LLCs and corporations are subject to corporation tax on profits, but rates are often calculated at a lower rate. 

When you consider taxes, you might want to consult with a tax expert who can look at local tax laws and guide you on which business structure option is most advantageous in terms of taxation. 

  1. Flexibility to Adapt

business-structure

Scalability is a factor many beginner business owners neglect to think about, but it’s an important consideration. During the startup period, most business owners are fully focused on opening their doors, but this is also the time to think about the future. Modern businesses need to be agile and scalable to adapt to technology, competitors, and other new trends that directly impact the ability to compete in any given industry. Anticipate the unknown. 

For example, a sole proprietor may have more difficulty accessing funding to expand or purchase new technology if they don’t have collateral or if their personal credit standing isn’t excellent. On the other hand, an LLC may find it easier to obtain a loan since they can offer stock as collateral and their individual credit standing won’t have an impact on the ability to obtain funding if the company needs to unexpectedly pivot. 

  1. Personal Risks

Entering entrepreneurship, regardless of structure, involves risks. Although, the risks you take will vary and be directly dependent upon the type of business structure you choose. Potential scenarios directly affecting your ability to successfully run your business might include: 

  • A partner leaves or passes away, which means you may have to carry on without the partner, work with their heirs, or have to close the business. 
  • A person files a personal injury lawsuit against your company and, if you’re a sole proprietor or partnership structure, you may be held fully and personally negligent (unlike LLCs or corporations that would otherwise absorb liability). 
  • If the company falls into debt, with an LLC or corporation, you, as an owner, will not lose your personal assets to pay off lenders, whereas if you are a sole proprietor, you could lose home, car, or have to drain your bank accounts. 
  • LLCs and corporations are subject to accountability by shareholders, other owners, and other vested parties because owners don’t have full control, unlike sole proprietors and partnerships who do enjoy full control in decision-making. 

Other potential risk factors to consider are the freedom to sell a business or the autonomy to expand. Before you register your company, carefully evaluate each business structure option to determine how it would fit into your personal goals for the long term. Speaking with an attorney, mentor, or other experienced expert who can help you run through various scenarios that can feasibly happen can help you come to the right decision. 

Final Thoughts

Taking your idea and bringing it to market by starting a new business is an exciting venture and opportunity. However, while you want to maintain enthusiasm, it’s critical to remain practical and think about the logistics affecting both the now and the future. 

The business structure you choose now cements you into following its rules throughout the lifetime of your company. This includes, but is not limited to taxes, costs, legal responsibilities, and raising capital, to name a few. Weigh all the pros and cons because what makes sense for one business owner may not make sense for another. Choose wisely!

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