The legal structure you choose for your business will affect your company structure, taxes, liabilities, stock offerings, and hiring. While you can change the structure later, it can be a long and complex process. Therefore, knowing your options when it comes to entity structuring is crucial.
The most common entity types are sole proprietorships, partnerships, limited liability companies, and corporations.
A sole proprietorship is the simplest and most commonly used entity structure where only one person owns the entire company. There is no minimum or maximum company size, and it does not need to be registered with the state.
Many freelancers and consultants are sole proprietors.
Pros of a sole proprietorship:
- A sole proprietorship is simple, easy to start, and overlaps with your personal finances.
- Business losses can be deducted on the owner’s personal tax return.
Cons of a sole proprietorship:
- It is difficult to change ownership or add a partner as it would require a change in structure.
- Risk is elevated because the owner is solely responsible for all debts and liabilities.
A partnership is not too different from a sole proprietorship. The main difference is that a business that is a partnership has two or more owners. There are two common types of partnerships: general and limited.
In a general partnership, all owners manage the business and share profits and losses. In a limited partnership, some owners may actively manage the business, but some may be investors. As the limited partners do not actively manage the business, they have fewer liabilities and pay less taxes.
Pros of a partnership:
- Partners share profit and losses. The losses are lower risk as they are split between partners.
- General partners can maintain control over a company and limited partners can invest. A limited partnership helps raise funds to run the business.
Cons of a partnership:
- A limited partnership involves more paperwork and expense since it needs to be filed with the state.
- As in a sole proprietorship, general partners are fully responsible for debts and liabilities. In a limited partnership, partners may become liable if taking too active a role in the management of the business.
Limited Liability Company
A limited liability company, or LLC, protects business owners from debts and liabilities, but allows the owners to get similar tax benefits to a sole proprietorship and partnership.
A corporation is a separate legal entity from the owners, and ownership can be sold in the form of stock. This entity structure is generally for larger businesses that need to raise capital through shareholders.
Pros of a corporation:
- Stockholders do not share any liabilities with the corporation. They are only liable for their own investments in the business.
- Owners and shareholders have no personal liabilities related to the corporation aside from their investment.
Cons of a corporation:
- A corporation is more complex to form and has a difficult filing process. Once formed, a corporation must also adhere to certain laws and regulations that affect the business structure.
- The business will not be dissolved as easily as a sole proprietorship or a partnership. The continuity of the business does not depend only on a set of owners.
There is a lot of nuance in the critical task of structuring your business, but Bennett Bennett & Trice can advise you in choosing the entity structure that is right for your unique circumstances.