When you decide to start your own business, one of the most important decisions you will make is determining which business entity is right for your business. This decision will have a huge impact on how the business is operated, how taxes are paid, and your personal liability. Different types of entities have different advantages and disadvantages that must be taken into consideration, but you should start with an understanding of exactly what each type of business entity is.
‘The sole proprietorship is the choice for most business startups, but it isn’t necessarily the best choice. What makes this type of business structure attractive is that it is the easiest and fastest way to set up a business. All that is required for a sole proprietorship is a business license, which can be obtained in about an hour by visiting your local courthouse, paying the fee, and filling out a short form.
A partnership is just like a sole proprietorship, except that there is more than one owner. Again, a business license will be required, and while not required, a legally binding partnership agreement is highly recommended. The agreement should include the rights and obligations of each partner, how profits and losses will be divided, and how the partnership will be dissolved should one of the partners want out. There are actually two types of partnerships — a general partnership, and a limited partnership. The main difference between the two is that in a limited partnership, the limited partner’s legal liability is limited to the amount of their investment, but this limited partner does not have an active role in running the business.
Corporations are more complicated to set up, but they also offer individuals the most protection. There is additional record keeping and administration work that must be done, but the business owner is not legally liable for the actions of the corporation. Should be businesses get into financial trouble, creditors cannot come after the individual’s assets. There are two types of corporations — C corporations and S corporations. C corporations have tax disadvantages, such as double taxation, and most businesses that incorporate choose the S corporation structure, which allows income to pass directly through to the individual shareholders.
The limited liability company (LLC) is an alternative to corporations that many small business owners look to. Like a corporation, the owners of the business are protected from liability, but the business is taxed as a sole proprietorship or partnership. There is typically less paperwork and expense involved in setting up an LLC, as opposed to setting up a corporation. This is the most feasible choice for many small businesses.
For the most protection, a small business owner should opt to either incorporate the business or form a limited liability company (LLC). Even though a sole proprietorship or partnership is easier to set up, and doesn’t cost as much to start, it just will not offer the business owner or owners an adequate amount of protection, and in the end, could cost the owners more money than the cost of setting up a corporation or LLC in the first place.