A Decision Not To Be Taken Lightly
At some point, most people dream of owning and operating their own business. For those who are willing to put forth the considerable amount of effort required to succeed, starting a business may be a wonderful idea. The biggest problem faced by many would-be entrepreneurs, however, is choosing the right business structure. There are many possible business structures from which to choose, and selecting the right one can be a daunting task.
There are several major factors that any aspiring business owner must take into consideration when choosing the right business structure for the new venture. These factors include, but are not limited to: ease and cost of startup, the size of the business, the owner's level of desired control, personal liability, tax implications, the ability to sell the business later, and the need for financing.
Forms of Business Ownership
Sole proprietorships are by far the most common business structure in the United States, accounting for approximately 72% of all businesses. From a legal point of view, a sole proprietorship and its owner are one and the same, and they cannot be separated. Starting this kind of business is very simple, requiring virtually no paperwork. This kind of business can have only one owner, who has complete control over the the business
A sole proprietor can be held personally liable for any and all damages done in the course of business operations. Due to this unlimited personal liability, all sole proprietors should carry liability insurance.
A proprietorship is taxed as personal income for the owner, a taxation method that is more favorable than that of a corporation. Because the business and the business owner are one and the same, selling a sole proprietorship is very difficult. Additionally, financing for the business is generally limited to that which the owner campaign personally.
A general partnership is an association of two or more persons operating business. Much like a sole proprietorship, partnerships are very easy to form and require almost no paperwork. It is always a good idea, however, to create and sign an operating agreement between the partners before ever conducting any business. This prevents misunderstandings and quarrels between partners, and can greatly simplify the process of ending the partnership or continuing its operation upon the death of a partner.
If there is no operating agreement in place, all partners have an equal share of control in the business. This can often pose problems, as two partners who disagree on how the business should be run may be caught at an impasse. It is advisable, therefore, that an operating agreement be in place giving one partner a 51% control over the operation of the business. This should be decided and agreed upon before the business ever begins to operate.
Like a sole proprietorship, a partnership is taxed at the individual tax rates of its members. Unless there is an operating agreement in place specifying otherwise, all profits from a partnership are split evenly between the partners. Also like a proprietorship, members of a general partnership have unlimited personal liability not only for their own acts, but for the acts of their partners in the course of doing business. Members of a general partnership should carry a significant amount of liability insurance.
Transferring ownership of a partnership is difficult, as it is one in the same with its owners from a legal standpoint.Â Also, financing opportunities for a partnership are generally limited to the personal credit that the partners can obtain.
A limited partnership is similar to a general partnership, with the exception of offering limited personal liability for some of its members. Any limited partnership must have at least one general partner, who is responsible for the actual operations of the business. This kind of partnership can also have limited partners, who share in its ownership but who are not actively engaged in business operations. The general partner still has unlimited personal liability for the actions of the partnership, but any limited partners do not suffer personal liability for the actions of the business. This structure is ideal for a partnership in which one or more members wish to provide only financial backing to the venture, rather than actively participate.
A C-Corporation is a "person in law", existing as an entity at the pleasure of the courts. Corporations are difficult, expensive, and time-consuming to create, but have some advantages over other forms of ownership. Corporations can be owned by any number of people, called stockholders. Each stockholder's control over the decisions of the business is proportional to their share of the company's outstanding stock.
Stockholders face no personal liability for the actions of their company. The price paid for this level of protection from liability, however, comes in the form of double-taxation. A corporation's profits are taxed once when they are earned by the company, and then again when they are distributed to the stockholders in the form of dividends.
Because ownership of a corporation comes in the form of stock, it is a very simple matter to transfer ownership of the corporation by simply selling one's shares. Obtaining financing for a corporation is also very simple, as it can simply sell additional shares of stock to raise capital.
An S-Corporation is a special kind of corporation with fewer than 100 stockholders. Due to their small size, S-Corporations are exempt from double-taxation and much of the paperwork required of C-Corporations. S-Corporations are limited in some ways, and cannot do some things that a C-Corporation can, such as issuing preferred stock.
Limited Liability Company (LLC)
Created in 1977, limited liability companies are a fairly new business structure that provide their owners with the liability protection of a corporation and the beneficial pass-through taxation of a partnership. LLC's are quickly becoming a popular form of business structure for small businesses, as they offer many of the best attributes of the other forms of business.Â The paperwork needed and the cost to create an LLC are, not surprisingly, more than a proprietorship or partnership, yet less than a corporation.