You’re about to launch a new venture to start your new journey. But which industry is most suitable for a startup? Making a decision about your company’s structure should be one of your first priorities. Will you be the sole proprietor of the startup or will you have partners? Although there are other legal ways to set up your company, limited liability companies (LLCs) and sole proprietorships are the two most popular. Each has benefits and drawbacks, and knowing the legal and financial repercussions can help you choose which is best for you.
A small business run by a solo proprietor typically has no workers. It is the most affordable and straightforward to form. Your income is transferred to your tax return as a “passthrough” business. An unincorporated business owned and operated by a lone proprietor is one in which there is no separation of the owner’s role from that of the company. You are entitled to all profits and are liable for all liabilities, losses, and debts incurred by your company.
An LLC, which is a combination of a partnership and a corporation, differs from a sole proprietorship in that it offers the tax benefits of a partnership as well as the liability protection of a corporation. On your taxes, an LLC is also a “passthrough” business.
Four things to consider when choosing your business structure
- Legal liability. To what extent do you as the owner want to be shielded from liability?
- Tax implications. Which business structure offers the best tax minimization?
- Cost of formation and ongoing record keeping.
- Future needs. Will you need financing? Do you want to create a new credit record for your business?
Sole Proprietorship:
A sole proprietorship has a number of advantages. Sole proprietorship would be a good fit for you if you are just getting started and testing the waters, you are the only owner, you are not looking to bring in a partner, you do not need significant capital, your business has a low risk of being sued, and you are not in a high growth industry. A single-person artist, small grocery store, plumber, carpenter, electrician, web designer, farmer, boutique owner, floral shop, barbershop, or restaurant are some examples of sole proprietorships.
- No annual paperwork
- No annual state filing
- Quick and inexpensive to form
- All profits/losses are passed through to the owner’s tax return and you are only responsible for paying personal federal, state, local, and Federal Insurance Contributions Act (FICA) taxes. You are not required to pay any specific business taxes or unemployment taxes.
Limited Liability Company (LLC)
LLC is a distinct legal person. Therefore, the fundamental benefit of an LLC is the protection of your personal assets. Assets that are not owned by the corporation are inaccessible to creditors. The activities of your partners or workers cannot be used against you as an owner or partner in a lawsuit. Nevertheless, you still risk being sued for negligence.
How Management Structures Differ
At a sole proprietorship, the company owner can make any business decisions without additional input, permission, or legal documents. Sole proprietorships are known to have a simpler structure of management because there’s only one person at the head of the business. As a sole proprietor you only have to make sure that your business is operating legally and safely, and to create a profit margin to reduce business debts.
LLCs can be more complex in terms of the management structures of your type of business. An LLC can be managed by the members or by a manager that’s specifically appointed. Anyone can find that structure in an LLC operating agreement. Not all states require an operating agreement for an LLC, but most businesses operating under them have one — especially with multiple members. An operating agreement details each member’s profit share, voting rights, and stake in the business.
Why choosing the right business structure is important
Each business structure has its advantages and disadvantages. Your chosen structure will impact aspects of your business, such as:
- Liability – Specific business structures protect your assets from lawsuits.
- Record keeping – Each business legal structure has a different tax form.
- Taxation – Some tax structures categorize their business income as personal income, while others tax business and personal income separately.
- Company hierarchy – Corporations must have a board of directors, while sole proprietorships and other structures do not.
- Registration – Your legal structure is a requirement for registering your business in your state.
- Fundraising – Your structure can block you from raising funds.
If you are an entrepreneur looking to start a new business this is an exciting time for you. Knowing the proper way to legally form your business will be an important first step. We will be glad to help you get started contact us now