You are ready to embrace the entrepreneurial life. This is an exciting time—but also one of uncertainty. Before you proceed with an LLC operating agreement or articles of incorporation, you will need to make arguably the most important decision of all: business entity classification. From sole proprietorship to C corp, options abound. Tread carefully; your choice could impact taxation, liability, and recordkeeping for years to come.
Before you proceed, it is important to gain a basic understanding of your options. The following are the most common business entities:
You now understand the basics of various business entities. Like many entrepreneurs, however, you may struggle to weigh the benefits and drawbacks of a myriad of available approaches. Ask yourself these key questions as you determine which business entity can best meet your company's unique needs:
The freelance lifestyle delivers freedoms enjoyed by neither traditional employees nor corporate entrepreneurs. Freelancing also delivers unique challenges. For some, however, the risk of liability is a worthy tradeoff for full freedom.
Your best bet for retaining complete control while minimizing recordkeeping obligations is a sole proprietorship. While you will not benefit from the separation of personal and professional assets associated with LLCs and corporations, you will avoid the hassle of extensive bookkeeping. You will also get the final say when making critical business decisions. With a conventional corporation, you would cede extensive control to the board of directors. As a business partner, you would need to consult the other owner, depending on your partnership agreement.
If you are already in business, look carefully at your operation—you may already be a sole proprietor. If you do not feel the need for greater liability protection, continue filing Form 1040 and Schedule C when tax season arrives.
Perhaps you and your spouse, sibling, or parent have always wanted to launch a business together. If you thoroughly trust one another and are willing to take on additional liability, a general partnership may be your best option. Remember, both parties in a general partnership are liable for the company's financial obligations. A strong bond of trust is therefore crucial to success with this type of entity, as are protective legal forms such as partnership agreements.
It is no secret that starting a business is challenging, but as a sole proprietor it could be simpler than you expect. Sole proprietorships lack the formal federal and state filing requirements associated with other businesses. At most, you will file a fictitious business name statement. It is likewise easy to launch a general partnership; just complete a general partnership agreement to avoid or mitigate future conflicts.
As a sole proprietor or partner, you can get away with little to no recordkeeping. That changes quickly when you enter LLC or corporation territory. At a minimum, you will need to draft articles of organization or articles of incorporation. Additionally, you must maintain entirely separate records for your personal and professional endeavors.
Certain industries are uniquely prone to liability issues. As an LLC or corporation, you can shield your personal assets in the event of a lawsuit or other legal action. If you suspect that you will eventually face liability issues, it is worth the peace of mind to secure LLC protection.
Procuring outside funding could prove next to impossible if you lack formal tax structure. As a corporation, you can sell stocks or shares to obtain much-needed funding, especially in the early stages. This may be a preferable option if you lack capital.
Double taxation may be associated with corporate structures, but it can easily be avoided by setting up an S corp. LLCs also sidestep double taxation.
Sole proprietorships and general partnerships are best suited to those who intend to expand their businesses slowly and steadily. S corps and C corps are far more scalable. If you hope to grow your business quickly, it is worth your while to invest the extra time and funding upfront to ensure access to funding down the road. Do you hope to exceed 100 shareholders? If so, you will need to form a C corp as S corps heavily restrict shareholder numbers.
What happens when you retire? As a sole proprietor, your business ends as soon as you step aside. Conversion from partnership to sole proprietorship may be possible, but C corps provide the best opportunity for cementing your entrepreneurial legacy.
The business decisions you make now could hold huge consequences in months and years to come. Weigh the concerns outlined above carefully to determine which type of business entity best suits your purposes.
Whether you intend to start a sole proprietorship, partnership, LLC, or corporation, you can count on LegalNature for help with necessary legal forms. Click here to get started with business formation.