Which Business Structure is Right for You?
By Jason A. Rothenburger, CPA
Starting a new business can be an exciting and nerve-wracking time. There are many important decisions that need to be made. One of those decisions is business structure. The most commonly used business structures are sole proprietorship, partnership, corporation, and limited liability company (LLC). Each one has advantages and disadvantages that must be carefully looked at before a decision is made. Let’s start off by looking at a few questions that you must consider before deciding which structure is right for your business.
- What is the risk of litigation against your business and what kind of protections would you like in place?
- What level of overall structure are you willing to deal with?
- What is your desire to pay fringe benefits to your employees?
- How much are you willing to spend on setup fees for your business structure?
- What is your desire to raise capital?
After asking yourself these questions and looking over the different business structures below your plan of action may become more clear and you can be on your way to deciding which structure is the best fit for you and your business.
Sole Proprietorship
Currently used by the majority of all businesses, a sole proprietorship is often suggested as the easiest and most cost-effective business form. There is minimal paperwork to start a sole proprietorship thus allowing the business owner to get up and running with relative ease. These businesses are owned by one person, who manages all day-to-day aspects of the business. All business assets are owned by the sole proprietor and he or she is also responsible for all liabilities incurred by the business.
Advantages
- Cheapest form of business structure
- Owner has complete control over day-to-day operations
Disadvantages
- Owner can be held personally liable if the business were to be sued
Partnership
A partnership consists of two or more partners. These partners manage all day-to-day aspects of the business and share in both the profit and loss of the company. Their contributions to the business consist of time, money, ideas, and personal skill that contribute to overall operations of the business. A partnership is required to have two or more partners at all times. If one partner exits, regardless of reason, the partnership ceases to exist.
Advantages
- Relatively easy to form
- Profits and losses of the business flow through to the partners
- Ability to raise capital may be increased
Disadvantages
- Partners are liable for the actions of the other partners
- Business profits must be shared
- Disagreements can easily occur unless guidelines are set
Corporation
A corporation is considered to be a unique legal entity separate from its owners or shareholders. A corporation can enter into legally binding contracts, can be sued, and can be taxed. Because a corporation is a separate entity, its shareholders have limited liability for the corporate debts or any legal judgments against the corporation. A corporation can elect a board of directors to oversee major decision making, although with most small businesses that are corporations the board of directors and the owners more often than not are one and the same. C-corporations and S-corporations are the two basic tax structures for corporations. Each one is different and affords unique advantages and disadvantages to its shareholders.
C-Corporation
Advantages
- Can raise capital through the sale of corporate stock
- Fringe benefits such as health insurance and direct medical reimbursements can be provided to its employees
Disadvantages
- Incorporation can be expensive
- Double taxation can occur
S-Corporation
Advantages
- Income and loss flows through to shareholders
- Owners may be able to use corporate losses to offset income from other sources
- Can avoid double taxation of C-corporations
- Tax planning can be more straightforward than a C-corporation
Disadvantages
- Fringe benefits are limited for shareholders who own 2% or more of the corporation
- Income is distributed according to shareholder ownership percentages
- Limitation on the number shareholders
Limited Liability Company (LLC)
An LLC affords many of the same protections that a corporation provides while at the same time providing its members with some of the tax advantages of a partnership. There is no minimum amount of members that an LLC can have, which makes it a good choice for a business with a single owner looking for some of the protections that a corporation provides without the potentially burdensome tax filings that can go along with that. Members are not limited to individuals; they can be trusts, corporations, or other organizations. An LLC can elect to be taxed as either a corporation or a partnership which provides its members some flexibility when forming the LLC.
Advantages
- Provides the same legal protections of a corporation
- Can have a single member
- More flexible than a corporation
- Income and loss flows through to shareholders if taxed as a partnership
Disadvantages
- Ability to provide fringe benefits to its members is limited
- More expensive to form than a partnership or sole proprietorship
Because it can be difficult and costly to change the legal structure of a business once it has been established, we suggest that you will want to spend considerable time analyzing the various legal structures. More than likely, you will also want to consult your attorney and CPA as well.
