One of the most difficult steps in the startup process is deciding which business structure fits your business idea best. There aren’t that many options, but the distinctions between the types of entities can be overwhelming. A lawyer can help you make the decision but with a little research, you may be able to choose yourself. Here are some pros and cons of the major business structures you can choose from.
A sole proprietorship is the default business structure if you don’t file anything with the Secretary of State. This isn’t always the best choice for everyone, as it can result in a higher frequency of audits and it doesn’t provide protection for your personal assets and you can be personally liable for business debts. However, it is simpler to get started and the profits or losses can be reported on your personal tax return, without filing separately.
Limited Partnership. A limited partnership offers protection for the personal assets of the limited partners, however the partners who are actively involved in management do not have any protection. This is a nice option for many companies that focus on investing in real estate as it allows money to be raised for the business without involving outside people in the management of the business. This type of structure requires a filing with the Secretary of State.
Limited Liability Company (LLC). The Limited Liability Company, commonly known as an LLC, is one of the most popular entity structures among businesses right now. It’s a relatively new structure that combines the benefits of the corporation structures but eliminates some of the negative aspects. Specifically, the LLC protects everyone in the company from personal liability for business debts and allows losses to be “passed-through” to the people involved in the company. This “pass-through” option is a huge benefit to the LLC because it means that the people involved in the company can claim the losses of the company on their personal tax returns. In an LLC, you can take on passive investors to raise financing and corporation maintenance is fairly easy.
A C-Corporation is the most general type of corporation you can have. The owners of a C-Corporation are mostly protected from personal liability for business debts, although if the corporation doesn’t follow the formalities of a corporation, there can be problems with personal liability. As a result, the formalities such as filing annual reports, maintaining separate bank accounts, keeping track of meeting minutes, and holding shareholders meetings are very important. A benefit of operation a C-Corporation is that the owners can share corporate profits with the corporation, lowering the overall tax rate. A C-Corporation can also have unlimited number of shareholders. A third benefit of C-Corporations is that if you wish to take your company public (selling shares over a public trade, i.e. NASDAQ or NYSE), you will need to be in a C-Corporation so starting out that way saves trouble down the road.
An S-Corporation is a C-Corporation that has specially elected to be treated as an S-Corporation. It has the same personal liabilities protections and potential issues although it has significantly more stringent formalities. An S-Corporation can only have a certain amount of shareholders and the shareholders must meet specific requirements. An S-Corporation also allows for corporate profit sharing, but the allocations must be done in accordance with the shares each owner owns. A benefit is that owners can use any losses of the corporation on their personal income tax returns, reducing personal tax liability in many instances.
Another thing to consider when choosing a business structure is that your state may have some restrictions regarding the types of businesses that can operate in each structure. The Secretary of State for your state may be able to provide some guidance about this or an online filing service can as well while they’re filing your paperwork, if you choose to use them.
As you can see, there are numerous advantages and disadvantages to each type of business structure. Depending on the type of business you are starting, some of these disadvantages may not affect you as much as others. The only thing is to make sure that the business structure works best for you, and you are familiar with the applicable requirements.
NOW WATCH: Ideas videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.