Which Business Structure is Right for Your Business?
Should I incorporate my small business? That’s a question most business owners ask themselves at some point in their career. Many may decide the answer is no, but for those who decide incorporation is something they need, there are many more questions to be answered. The major differences between business structures are usually tax, liability and ownership related, which means it’s pertinent to explore all your options and consult professionals for help before making a decision. Tweet This We’ve outlined some of the basics below, including the pros, cons and challenges of four major business structures. You can use this guide to get an idea of which business structure may be best for you either right now or in the long run, and then consult with a lawyer, and accountant, or both, to help you make your final decision.
A sole proprietorship is generally the business structure initially adopted by freelancers, independent contractors and other individuals who run a business on their own with their personal services and skills. A sole proprietorship is the simplest structure because there’s no distinction between the individual and the business, but this lack of separation also makes this one of the most risky structures.
Similar to a sole proprietorship are the partnership business structures.
A general partnership, just like a sole proprietorship, does not require state filing, making it an easy option for new small businesses that do not wish to expand or bring on investors. A general partnership does not offer protection of personal assets, but it does incur very low to no costs.
With a limited partnership (LP), two or more individuals are responsible for the business, but the general partner has unlimited personal liability for the business while the limited partner has limited liability and cannot participate in management. Generally the limited partner acts as a silent investor and his/her personal assets are not used for business liabilities. Films and family estates are often set up as LPs.
With a limited liability partnership (LLP), two individuals own the business and are both equally personally liable. A general partnership is not risk averse, as each partner can be held personally responsible for the decisions of the other. An LLP also does not protect against malpractice, and can only be formed by certain professions, such as doctors, attorneys, or accountants.
An LLC is the business structure commonly adopted by sole proprietors or small businesses with more than one owner. Unlike a sole proprietorship, an LLC provides limited liability, and helps protect the personal assets of the owners. Sole proprietors may decided to incorporate as an LLC for many reasons, including tax benefits, the ability to build business credit, get bigger contracts, or obtain funding.
A corporation is divided into two separate structures, both of which are more expensive to form than an LLC and are subject to more regulations. For these reasons, corporations are usually formed by medium and large businesses, but still may not be wrong for smaller businesses, as these structures offer significant growth benefits.
An S Corp is often chosen by medium sized businesses to help them grow and manage past growth. Some small businesses scale very quickly and outgrow their current structure. An LLC that sees massive growth may decide to reincorporate as an S Corp to help create more separation between the owner and the business, for tax benefits, to help attract investors, or all of the above.
A C Corp is one of the most well-known business structures because some of the world’s biggest and most popular businesses are C Corps. This structure is usually selected by large businesses because it legally operates as an individual, meaning it can buy, sell, sue, and be sued. It is run by a board of directors who appoint officers and can have thousands of shareholders. C Corps have the most regulations and are subject to double taxation, but for large companies with hundreds of employees and millions or more in profits, a C Corp offers the most benefits and protections.
7 Keys to Analyzing Your Business Structure
Here are seven things to consider when analyzing your company that can help determine whether or not you are operating under the appropriate business structure.
#1: Is the Business Engaging in Riskier Activities?
The riskier your business is, the more protected you need to be. Therefore, if your company is a sole proprietorship or a partnership, and it has started engaging in riskier activities or it is requiring more capital from outside funding, then you should consider updating its business structure to an LLC or a corporation. By going with one of these two structures, your personal risk can be significantly reduced, even if your business’s risk is rising.
#2: Have Your Personal Assets Increased Substantially?
If your personal wealth has increased substantially since you started your business, then you should do everything you can to keep your assets safe. Consider changing your business structure to an LLC or a corporation. If you currently have a sole proprietorship or a partnership, and your company goes under, then you will be personally liable for all business debts and obligations, and your assets will be at risk.
#3: Has Your Business Risk Outgrown Its Insurance Protection?
Sometimes, running a sole proprietorship or partnership is perfectly fine — as long as you have an insurance policy that’s capable of covering any expected issues. But if your business is branching out and the insurance won’t be enough to cover all of your risks, then changing your business structure might make more sense.
#4: Is Your Business Becoming More Profitable?
If your business is growing by leaps and bounds and it is starting to become highly profitable, then you may want to consider changing to a corporation to take advantage of the tax benefits. Doing so can help keep profits (retained earnings) in the corporation every year, where they will be taxed at a reduced corporate tax rate.
On the other hand, if you own a sole proprietorship, a partnership, or an LLC, then you may have pay taxes on all of the company’s income, regardless of how much money you actually took out of the business as personal income.
#5: Do You Want to Attract Investors by Offering Stock Options?
One of the best ways to attract investors is to offer stock options, but only corporations can do this. Therefore, if your business has grown to the point that you are considering offering stock options to investors and/or employees, then you will have to change your legal structure over to a corporation.
#6: Do You Want Special Fringe Benefits for Yourself or Your Employees?
Corporations come with certain benefits often called fringe benefits. These can include such things as tax-exempt health insurance, and medical expense reimbursements for employees and managing members. Although other business structures can also deduct the costs of these things as business expenses, a difference is that the business owner can still be taxed on their value, whereas corporations may not.
#7: Are You Worried About Losing Your Independent Contractor Status?
If you are an independent contractor and you are worried about the IRS reclassifying you as an employee, then restructuring your business as a corporation can help you retain your status as an independent contractor.
Photo Credit: @sofiamilkis via Twenty20