To start a business, aspiring entrepreneurs have to make hundreds of different decisions before opening their doors to clients. One of the most important decisions is choosing the right legal form for your company. How you choose to organize will affect your taxes, personal liability, and ability to raise funds.
Sole proprietorships are the most common form for individuals who work alone. This structure is a popular choice because it is the easiest to arrange and requires no filings with the state. However, one of the major disadvantages of sole proprietorship is that there is no entity outside of the owner. Consequently, the owner is personally liable for all financial obligations and damages resulting from lawsuits against the company. Another downside is that raising capital can be difficult. Banks are reluctant to lend to sole proprietorships, leaving homeowners to rely on home equity or family loans.
For companies with more than one owner, a partnership can be a good solution. Each partner contributes capital, labor or know-how to generate a profit. The shareholders participate in the profits, but are also personally liable for debts and damages like a sole proprietorship. One way partners can reduce personal risk is by forming a limited partnership. This form consists of general partners who make decisions and assume the risks, and limited partners with no control over operations in exchange for reduced liability. The tax treatment is one of the main reasons for choosing this scheme. Profits and losses are passed on to the individual shareholders.
Limited Liability Companies or LLCs are a type of structure that is becoming increasingly 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 company. In contrast to a limited partnership, all partners are freely involved in the management and enjoy protection from personal liability. LLCs also enjoy pass-through taxation. However, the tax regulations for these structures are complicated. The amount of paperwork is a major hurdle and members must submit the Articles of Association 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 business. For example, a small boutique that sells handmade cat collars obviously has less risk and perhaps less revenue than a company that provides window cleaning services for high-rise office buildings. Prospective entrepreneurs are advised to consult their solicitor or accountant to discuss the tax and liability implications of different companies. A number of free or low-cost resources to help you make a decision are available from your local Chamber of Commerce, Small Business Administration, or Service Corps of Retired Executives volunteers.
Choosing the organization for your business is one of the most important decisions you and your partners will make. Find out about all the options available and get advice from experienced professionals before making your choice.