The first step in deciding on a business structure is determining whether or not you require personal liability insurance.
Businesses that are exposed to any level of risk require liability insurance.
What exactly is personal liability insurance? Liability insurance can help you build a legal barrier between your personal and company assets.
Because the business is legally separated from its owner, formal business forms such as LLCs and corporations provide liability protection.
Because there is no distinction between the business and the owner, informal business forms such as sole proprietorships and partnerships do not provide security. As a result, the owners’ personal assets are entirely vulnerable to creditors and law enforcement.
Choosing the appropriate legal structure is an important aspect of running a company. It’s critical to understand your alternatives, whether you’re just starting out or your company is expanding.
Depending on the entity’s finance and liability structure, partnerships can operate as either a sole proprietorship or a limited liability partnership.
If it cannot be shown that members of an LLC behaved in an unlawful, unethical, or negligent manner in carrying out the business’s activities, they are immune from personal responsibility for the debts of the company.
Corporations can sell stock to raise money for expansion, but single proprietors can only get money from their own bank accounts, personal credit, or taking on partners.This page is for company owners who want to learn more about the various legal structures for small businesses.
Analyzing your firm’s goals and evaluating local, state, and federal regulations are the first steps in determining the best legal structure for your company. You may choose the legal structure that best suits your company’s culture by outlining your aims. You can modify your legal form as your company expands to meet its new demands.
To assist you in deciding on the appropriate legal structure for your company, we’ve created a list of the most popular forms of business entities and their distinguishing characteristics.
Different kinds of business arrangements
Sole proprietorships, partnerships, limited liability companies, corporations, and cooperatives are the most prevalent forms of business entities. Here’s additional information about each legal framework.
1. One-person business
This is the most basic type of business structure. In a sole proprietorship, one individual is solely liable for the earnings and obligations of the business.
“A sole proprietorship allows you to be your own boss and manage a business from home without having to have a physical storefront,” said Deborah Sweeney, CEO of MyCorporation. “This organization does not provide for the separation or protection of personal and professional assets, which might become a problem as your firm expands and more elements of it hold you responsible.”
The cost of a proprietorship varies based on the market in which your company operates. State and federal fees, taxes, equipment demands, office space, banking costs, and any professional services your firm decides to contract are all examples of early expenses. Freelance writers, teachers, bookkeepers, cleaning service providers, and babysitters are examples of these companies.
Some of the advantages of this company structure are as follows:
Setup is simple. The simplest legal form to establish is a sole proprietorship. This may be the ideal business form for you if your company is solely owned by you. Because you have no partners or executive boards to answer to, there is relatively little paperwork.
The price is low. License fees and business taxes are the only expenses connected with a proprietorship, and they vary based on which state you live in.
Deduction for taxes. You may be qualified for some company tax deductions, such as a health insurance deduction, because you and your firm are a single entity.
Exit is simple. Creating a sole proprietorship is simple, as is leaving one. You can disband your firm at any moment as a sole proprietor with no official paperwork necessary. For example, if you open a daycare facility and decide to close it down, you may simply stop running it and advertise your services.
Sole proprietorships include the following:
One of the most frequent legal forms for small businesses is the single proprietorship. Many well-known firms began as sole proprietorships and evolved into multibillion-dollar enterprises.
This business is owned by two or more people. A general partnership, in which all earnings are shared equally, and a limited partnership, in which only one partner controls the business while the other person (or individuals) contributes to and receives a portion of the profits, are the two varieties. Depending on the entity’s finance and liability structure, partnerships can operate as either a sole proprietorship or a limited liability partnership (LLP).
“This entity is excellent for anybody who wants to start a business with a family member, friend, or business partner, such as a restaurant or an agency,” Sweeney added. “Within the company structure, a partnership allows participants to share earnings and losses and make decisions jointly. Keep in mind that you will be held accountable for your judgments as well as your business partner’s conduct.”
A general partnership might be more expensive than a sole proprietorship since you’ll need an attorney to examine your partnership agreement. The pricing range is influenced by the attorney’s experience and region. For a general partnership to be effective, it must be a win-win situation for both parties.
Google is an example of this sort of company. Larry Page and Sergey Brin co-founded Google in 1995 and grew it from a tiny search engine to the world’s most popular search engine. The co-founders met while earning their doctorates at Stanford University and subsequently departed to create a beta version of their search engine. They acquired $1 million in capital from investors shortly after, and Google began seeing thousands of visits each day. They have a combined net worth of approximately $46 billion due to their ownership of 16 percent of Google.
Here are a few of the benefits of forming a business partnership:
It’s simple to make. There isn’t as much paperwork to file as there is with a single proprietorship. If your state requires you to conduct business under a false name (“doing business as,” or DBA), you’ll need to submit a Certificate of Conducting Business as Partners and create an Articles of Partnership agreement, both of which come with extra expenses. In most cases, a business license is also required.
Possibility of expansion. When there are several owners, you have a better chance of getting a company loan. If you have a bad credit score, bankers may consider two credit lines rather than one.
Taxation with a difference. General partnerships are required to file federal tax Form 1065 as well as state filings, although they rarely pay income tax. On their individual income tax forms, both partners record their joint income or loss. You and your friend are co-owners if you started a bakery with a friend and organised the business as a general partnership. Each owner contributes to the company a specific amount of knowledge and working capital, which might influence each partner’s share of the company and contribution. Let’s assume you contributed the most seed cash to the company; it’s possible that you’ll be given a greater share percentage, thus making you the majority owner.
Examples of collaborations
Partnerships are one of the most prevalent forms of company arrangements, second only to sole proprietorships. Here are some examples of successful collaborations:
- Warner Brothers
- Hewlett Packard
- Ben & Jerry’s
3. Limited Liability Corporation (LLC)
A limited liability corporation (LLC) is a hybrid form that allows owners, partners, or shareholders to restrict their personal responsibilities while still benefiting from the tax and flexibility of a partnership. If it cannot be shown that members of an LLC behaved in an unlawful, unethical, or negligent manner in carrying out the business’s activities, they are insulated from personal responsibility for the debts of the company.
“Limited liability companies were established to give company owners the same liability protection as corporations while also enabling revenues and losses to pass through to the owners as income on their personal tax returns,” said Brian Cairns, CEO of ProStrategix Consulting. “LLCs can have one or more members, and earnings and losses don’t have to be split evenly among them.”
The state filing fee, which can range from $40 to $500 depending on the state, is included in the cost of creating an LLC. The state of New York, for example, charges a $200 registration fee and a $9 biennial cost for forming an LLC. You must also file a biannual statement with the New York State Department of State. [For a step-by-step guidance on how to form an LLC, see our guide].
Despite the fact that small firms can form LLCs, some major corporations do so. Anheuser-Busch Companies, one of the largest beer companies in the United States, is an example of an LLC. Anheuser-Busch is a wholly owned subsidiary of Anheuser-Busch InBev, a worldwide brewing corporation founded in Leuven, Belgium, with headquarters in St. Louis, Missouri.
Examples of limited liability companies (LLCs)
The LLC is commonly used by accounting, tax, and legal firms, but it can also be used by other sorts of businesses. The following are some well-known examples:
- Hertz Rent-a-Car
A company is treated by the law as a distinct entity from its owners. It possesses legal rights independent of its owners, including the ability to sue and be sued, acquire and sell property, and sell ownership rights in the form of stocks. Fees for forming a corporation differ by state and charge type. The S corporation and C corporation costs in New York, for example, are $130, while the nonprofit charge is $75.
Companies can be classified as C corporations, S corporations, B corporations, closed corporations, or nonprofit corporations.
C companies, which are owned by shareholders, are taxed separately. Morgan Chase & Co. is a C corporation that is a worldwide investment bank and financial services holding business. Many bigger firms, such as Apple Inc., Bank of America, and Amazon, register for C corporations because they enable an unlimited number of stockholders.
S corporations, like partnerships and LLCs, were created for small enterprises to avoid double taxation. Owners are also only covered for a limited amount of responsibility. Widgets Inc. is an example of a straightforward S company: employee wages are subject to FICA tax, but further earnings distributed by the S corporation are not subject to additional FICA tax.
B companies, often known as benefit corporations, are for-profit businesses that aim to have a beneficial social effect. The Body Shop has earned B company certification after demonstrating a long-term commitment to environmental and social causes. The Body Shop utilises its presence to fight for long-term change on topics such as human trafficking, domestic abuse, climate change, deforestation, and cosmetic industry animal experimentation.
Closed corporations are not publicly traded and have minimal liability protection. They are generally managed by a few stockholders. Closed corporations, often known as privately held firms, offer more freedom than publicly listed organizations. Hobby Lobby is a privately held, family-owned company that operates as a closed corporation. Hobby Lobby equities aren’t traded on the open market; instead, they’ve been allotted to family members.
On a public market, open corporations can be traded. Many well-known businesses, such as Microsoft and Ford Motor Company, operate as open organizations. Each entity has assumed control of the business and is now open to investment from anybody.
Nonprofit organizations exist to assist others in some capacity, and they are rewarded with tax exemption. The Salvation Army, the American Heart Association, and the American Red Cross are examples of nonprofits. The only objective of these sorts of company arrangements is to focus on something other than making a profit.
The following are some of the benefits of this company structure:
Liability is limited. Stockholders are only accountable for their own investments and are not personally liable for claims against your company.
Continuity. Death or the transfer of shares by shareholders have no effect on corporations. Investors, creditors, and customers prefer that your firm continues to function indefinitely.
Capital. When your company is incorporated, it is considerably easier to raise substantial sums of money from many investors.
Rather than a startup housed in a livin
g room, this sort of business is appropriate for firms that are farther along in their growth. For example, if you’ve created a shoe company and have already given it a name, chosen directors, and obtained funds from investors, the next step is to incorporate. You’re basically doing business at a higher-risk, higher-reward rate. Additionally, your company might file as a S corporation to take advantage of the tax benefits that come with it.
Corporations that are examples
It’s probably in your best interest to incorporate your firm once it reaches a particular size. There are several well-known instances of companies, such as:
- General Motors
- Exxon Mobil
- Domino’s Pizza
- P. Morgan Chase
A cooperative (co-op) is a business that is owned and operated by the people it serves. Its services benefit the company’s members, also known as user-owners, who vote on the mission and direction of the organisation and share earnings. Cooperatives have the following benefits:
Reduced taxes. A cooperative, like an LLC, does not tax its members’ earnings.
Funding has been increased. Federal funding may be available to assist cooperatives get founded.
Discounts and improved service are available. Cooperatives can take use of their scale to get discounts on goods and services for their members.
Choosing a business name that specifies whether the cooperative is a corporation, such as incorporated (Inc.) or limited, is a difficult task. The cost of registering a co-op agreement varies by state. The filing charge for an incorporated business in New York, for example, is $125.
CHS Inc., a Fortune 100 company owned by agricultural cooperatives in the United States, is an example of a co-op. CHS, the country’s largest agriculture cooperative, has announced a net income of $829.9 million for the fiscal year that ended on August 31, 2019.
Cooperatives as examples
Co-ops, unlike other forms of enterprises, are owned by the individuals who use them. Co-ops include the following notable examples:
- Land O’Lakes
- Navy Federal Credit Union
- Ace Hardware
Consider these factors before deciding on a business structure.
It’s not always simple to select which structure to use for new firms that fall into two or more of these categories. You should think about your startup’s financial demands, risk, and growth potential. It might be tough to change your legal structure after you’ve established your company, so think about it carefully when you’re just starting out.
Here are some key things to think about while deciding on a legal structure for your company. You should also schedule a meeting with your CPA to get his or her counsel.
Where do you see your company going, and what kind of legal structure will allow it to develop the way you want it to? Review your goals in your company strategy and choose which structure best fits those aims. Your organisation should foster the prospect of development and change rather than stifle it.
Nothing beats a sole proprietorship when it comes to starting and operational complexity. You just register your business name, begin conducting business, declare your profits, and pay personal income taxes on it. Outside money, on the other hand, can be difficult to come by. Partnerships, on the other hand, need a written agreement that spells out the responsibilities and profit splits. State governments and the federal government have different reporting obligations for corporations and limited liability companies.
Because it is its own legal entity, a corporation carries the least degree of personal culpability. This implies that creditors and consumers can sue the company, but they won’t be able to seize the executives’ or shareholders’ personal assets. An LLC provides the same level of protection as a sole proprietorship while also providing tax benefits. Partnerships divide liabilities among the partners according to the terms of their partnership agreement.
An LLC owner pays taxes in the same way that a single proprietor does: all profits are treated as personal income and taxed as such at the end of the year.
Each year, a corporation files its own tax returns, paying taxes on earnings after deducting expenditures such as wages. If you pay yourself from the business, you will have to pay personal taxes on your personal return, such as Social Security and Medicare.
A sole proprietorship or an LLC may be the best option for you if you desire sole or main control over your firm and its operations. Control can also be negotiated in a cooperation agreement.
A corporation is designed to have a board of directors that makes the company’s main decisions. A single individual can govern a business, especially at its start, but as it expands, the necessity for it to be run by a board of directors rises as well. The standards meant for bigger companies – such as keeping track of every important action that impacts the firm – nevertheless apply to small businesses.
Investment in capital
If you require outside money, such as from an investor, venture capitalist, or bank, forming a company may be a preferable option. Corporations are more likely than single proprietorships to be able to attract outside investment.
Corporations can sell stock to raise money for expansion, but single proprietors can only get money from their own accounts, personal credit, or by bringing in partners. An LLC might suffer comparable challenges, however because it is its own business, the owner does not always need to utilise their own credit or assets.
Regulations, licences, and permissions
You may require certain licences and permits to operate in addition to properly registering your company organisation. Depending on the sort of business and its activity, local, state, and federal licences may be required.
Friedman explained that “states have various criteria for different company forms.” “There may be various regulations at the municipal level depending on where you start your shop. Understand the state and industry you’re in when you pick your structure. It isn’t a ‘one-size-fits-all’ solution, and firms may be unaware of what is relevant to them.”
Only for-profit enterprises are covered by the structures mentioned here. Friedman recommends meeting with a business law professional if you’ve done your homework and still aren’t sure which business structure is best for you.
” This blog offers generic information. By no means, it is professional advice. The information aforementioned is believed to be factually correct. The information provided is solely based on the author’s judgment and is subject to change. This is not endorsed by any 3rd parties or other brands.”
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