Best Legal Structure for Your Business

Best Legal Structure for Your Business

How to Choose the Best Legal Structure for Your Business

Choosing the right legal structure is a necessary part of running a business. Whether you’re just starting out, or your business is growing, it’s important to understand the options.

This page is intended for business owners who want to learn more about the various small business legal structures.

  • Depending on the entity’s finance and liability structure, partnerships can operate as either a sole proprietorship or a limited liability partnership.
  • Under an LLC, members are shielded from personal accountability for the business’s debts if it cannot be demonstrated that they acted illegally, unethically, or irresponsibly in carrying out the business’s activities.
  • Corporations can sell stock to gain more cash for growth, but single proprietors can only obtain funds through personal accounts, personal credit, or taking on partners.

Choosing the best legal structure for your company begins with examining your firm’s aims and taking into account local, state, and federal legislation. You can choose the legal structure that best fits your company’s culture by establishing your aims. As your company expands, you can modify its legal structure to match its changing demands.

We’ve created a list of the most popular forms of business entities and their distinguishing characteristics to assist you in deciding on the right legal structure for your company.

Different types of business structures

Sole proprietorship, partnerships, limited liability companies, corporations, and cooperatives are the most frequent types of business entities. Here’s more information on each type of legal structure.

1. Single-person business

This is the most basic type of business entity. A sole proprietorship means that one person is personally liable for all of the company’s profits and debts.

“A sole proprietorship allows you to be in complete control if you want to be your own boss and manage a business from home without a physical storefront,” said Deborah Sweeney, CEO of MyCorporation. “This company does not provide for the separation or protection of personal and professional assets, which may become a concern as your firm grows and more aspects hold you liable.”

The cost of being a sole proprietor varies depending on the market in which your company operates. In general, your initial expenses will include state and federal fees, taxes, equipment requirements, office space, banking fees, and any professional services that your company decides to hire. Freelance writers, instructors, bookkeepers, cleaning service providers, and babysitters are some examples of these enterprises.

The following are some of the benefits of this business structure:

  • Easy to set up. A sole proprietorship is the most basic legal form to establish. If you are the sole owner of your company, this may be the best structure for you. Because you have no partners or executive boards to answer to, there is relatively little paperwork.
  • .Affordability. The costs vary based on where you live, but the only expenditures involved with a sole proprietorship are licence fees and business taxes.
  • Deduction for taxes. Because you and your company are one and the same, you may be qualified for certain business tax breaks, such as a health insurance deduction.
  • Easy out. Forming a sole proprietorship is simple, as is quitting one. You can dissolve your firm as a sole proprietor at any moment, with no official paperwork required. For example, if you open a daycare facility and decide to close it down, you can simply stop operating the daycare and stop advertising your services.

Sole proprietorship examples:

One of the most prevalent legal arrangements for small businesses is the single proprietorship. Many well-known businesses began as sole proprietorships and developed into multi-million dollar enterprises. Here are a few examples:

  • eBay
  • JC Penny
  • Walmart
  • Marriott Hotels

2. Collaboration

This entity is owned by two or more people. There are two kinds of partnerships: general partnerships, in which everything is shared equally, and limited partnerships, in which only one partner controls the operation while the other person (or persons) contributes to and receives a portion of the earnings. Partnerships can operate as either a sole proprietorship or a limited liability partnership (LLP), depending on the funding and liability structure of the company.

“This organisation is great for anyone who wishes to start a business with a family member, friend, or business partner, such as running a restaurant or agency together,” Sweeney explained. “Within the corporate structure, a partnership allows participants to share earnings and losses and make decisions jointly. Remember that you will be held accountable for your judgments as well as the conduct of your business partner.”

The cost of forming a general partnership varies, but it is higher than the cost of forming a sole proprietorship because you will need an attorney to examine your partnership agreement. The pricing range might be influenced by the attorney’s experience and location. To be successful, a general partnership must be a win-win situation for both parties.

Google is an example of this type of company. Larry Page and Sergey Brin co-founded Google in 1995 and grew it from a modest search engine to the world’s largest search engine. The co-founders met while earning their doctorates at Stanford University and later left to build a beta version of their search engine. Soon after, they received $1 million in investor investment, and Google began seeing thousands of visits every day. With a combined stake of 16 percent in Google, they have a net worth of roughly $46 billion.

  • Simple to form. There is little paperwork to file, as there is with a sole proprietorship. If your state requires you to do business under a fake name (“doing business as,” or DBA), you’ll need to file a Certificate of Conducting Business as Partners and write an Articles of Partnership agreement, both of which come with additional expenses. In most cases, a business licence is also required.
  • Possibility of expansion When there are multiple owners, you have a better chance of obtaining a company loan. If you have a less-than-perfect credit score, bankers may consider two credit lines rather than one.
  • Distinctive taxation. General partnerships must file federal tax Form 1065 as well as state forms, but they do not normally pay income tax. On their individual income tax forms, both partners record their joint income or loss. For example, if you and a friend create a bakery and organise the company as a general partnership, you and your friend are co-owners. Each owner brings a different amount of knowledge and working capital to the table, which might influence each partner’s portion of the company and their contribution. Assume you contributed the most seed capital to the company; it may be decided that you maintain a larger share proportion, making you the majority owner.

Partnership examples

Partnerships are one of the most frequent types of business formations, second only to sole proprietorships. Here are some examples of successful collaborations:

  • Warner Brothers
  • Hewlett Packard
  • Microsoft
  • Apple
  • Ben & Jerry’s
  • Twitter

3. Limited liability company

A limited liability corporation (LLC) is a hybrid form that allows owners, partners, or shareholders to minimise their personal obligations while benefiting from the tax and flexibility advantages of a partnership. Members of an LLC are protected from personal accountability for the debts of the business if it cannot be demonstrated that they acted illegally, unethically, or irresponsibly in carrying out the business’s activities.

“Limited liability companies were created to provide business owners with the liability protection that corporations enjoy while allowing earnings and losses to pass through to the owners as income on their personal tax returns,” Brian Cairns, CEO of ProStrategix Consulting, explained. “LLCs can have one or more members, and profits and losses are not required to be distributed equally among members.”

The state filing fee, which can range from $40 to $500 depending on the state in which you file, is included in the cost of incorporating an LLC. In the state of New York, for example, there is a $200 filing cost and a $9 biennial fee if you form an LLC. You must also file a biannual statement with the New York Department of State. [See our step-by-step instruction on how to form an LLC].

Although LLCs can be formed by small firms, several huge corporations choose this legal structure. Anheuser-Busch Companies, a leader in the US beer industry, is an example of an LLC. Anheuser-Busch is a completely owned subsidiary of Anheuser-Busch InBev, a multinational brewing business headquartered in Leuven, Belgium.

Examples of LLCs

The LLC is commonly used by accounting, tax, and law firms, although other types of businesses can also file as LLCs. Some well-known instances are:

  • Pepsi-Cola
  • Sony
  • Nike
  • Hertz Rent-a-Car
  • eBay
  • IBM

A corporation is treated by the law as a separate entity from its owners. It has legal rights apart from its owners — it can sue and be sued, acquire and sell property, and sell ownership rights in the form of stocks. Fees for filing a corporation vary by state and charge category. In New York, for example, the S and C corporation fees are $130, while the nonprofit fee is $75.

4. Corporation

Companies are classified as C corporations, S corporations, B corporations, closed corporations, and nonprofit corporations.

  1. C corporations, which are owned by stockholders, are taxed separately. Morgan Chase & Co. is a C corporation that is a multinational investment bank and financial services holding business. Because C corporations can have an infinite number of shareholders, many larger corporations, like Apple Inc., Bank of America, and Amazon, file for this tax structure.

2. S companies, like partnerships or LLCs, were created for small enterprises to avoid double taxation. Owners have minimal liability protection as well. Widgets Inc. is an example of a simple S corporation: employee salaries are subject to FICA tax, but distributions of additional profits from the S business do not generate further FICA tax burden.

3. B corporations, sometimes known as benefit corporations, are for-profit organisations that aim to have a positive impact on society. The Body Shop has demonstrated a long-term commitment to environmental and social initiatives, earning it B corporation recognition. The Body Shop’s presence is used to advocate for long-term change on topics such as human trafficking, domestic abuse, climate change, deforestation, and animal experimentation in the cosmetic business.

4. Closed corporations are not publicly listed and benefit from minimal liability protection. They are typically operated by a few stockholders. Closed corporations, sometimes known as privately held enterprises, offer more flexibility than publicly traded companies. Hobby Lobby is a for-profit corporation; it is a privately held, family-owned company. Hobby Lobby stocks are not publicly traded; rather, they have been distributed to family members.

5. Open corporations can be traded on a public market. Many well-known organisations, such as Microsoft and Ford Motor Company, are open corporations. Each corporation owns the firm and permits anyone to invest in it.

6. Nonprofit corporations exist to benefit people in some way and are tax exempt. Nonprofit organisations include the Salvation Army, the American Heart Association, and the American Red Cross. These types of corporate structures have a single purpose: to focus on something other than profit.

5. Cooperative

A cooperative (co-op) is owned by the individuals who use it. Its offerings benefit the company’s members, also known as user-owners, who vote on the mission and direction of the organisation and share earnings. Cooperatives provide the following benefits:

  • Reduced taxes. A cooperative, like an LLC, does not tax its members on their earnings.
  • Additional financing. Cooperatives may be eligible for federal funding to assist with their initial development.
  • Discounts and improved service. Cooperatives can take use of their scale to receive discounts on products and services for their members.

Forming a cooperative is complicated, and you must choose a business name that reflects whether the co-op is incorporated (Inc.) or limited. The filing fee for a co-op agreement varies by state. The filing charge for an incorporated business in New York, for example, is $125.

CHS Inc., a Fortune 100 company owned by agricultural cooperatives in the United States, is an example of a co-op. CHS, the nation’s leading agribusiness cooperative, recently recorded a net profit of $829.9 million for the fiscal year ended August 31, 2019.

Examples of cooperatives

Co-ops, unlike other forms of businesses, are owned by the people they serve. Co-ops that are notable include:

  • Land O’Lakes
  • Navy Federal Credit Union
  • Welch’s
  • REI

6. Factors to consider before choosing a business structure

It’s not always straightforward to pick which structure to use for new enterprises that could fall into two or more of these categories. You must examine your startup’s financial requirements, risk, and growth potential. It can be difficult to change your legal structure after you’ve established your company, so consider it carefully in the early phases of organising your company.

Here are some crucial aspects to consider while deciding on a legal structure for your company. You should also plan on consulting with your CPA for advice.

1. Flexibility

Where do you want your firm to go, and what kind of legal structure will allow it to grow? Examine your business plan to determine which structure best corresponds with your aims. Your entity should foster the prospect of development and change rather than stifle it.

2. Complexity

Nothing is simpler in terms of setup and operating complexity than a sole proprietorship. Simply register your name, begin a business, report your profits, and pay personal income taxes on it. However, obtaining outside finance can be problematic. Partnerships, on the other hand, necessitate a formal agreement outlining the duties and profit shares. Corporations and limited liability companies must comply with a variety of reporting requirements with state and federal governments.

3. Liability

Because the law considers a company to be its own entity, it carries the least level of personal liability. This means that creditors and consumers can sue the corporation, but they cannot seize the officers’ or shareholders’ personal assets. An LLC provides the same level of protection, but with the tax advantages of a sole proprietorship. Partnerships divide liabilities among partners according to the terms of their partnership agreement.

4. Taxes

An LLC owner pays taxes in the same way that a single proprietor does: all profits are considered personal income and are taxed accordingly at the end of the year.

“As a small business owner, you want to avoid double taxation in the beginning,” Jennifer Friedman, chief marketing expert at Expertly.com, explained. “The LLC structure prohibits this and ensures that you are taxed as an individual rather than a company.”

Individuals in a partnership can also claim a portion of the profits as personal income. To minimise the impact on your tax return, your accountant may recommend quarterly or biannual advance payments.

Every year, a corporation files its own tax returns, paying taxes on profits after expenses such as wages. If you receive compensation from the corporation, you will have to pay personal taxes, such as Social Security and Medicare, on your personal return.

5. Control

If you want complete or main control over your business and its operations, a sole proprietorship or an LLC may be the best option for you. Such power can also be negotiated in a partnership agreement.

A corporation is designed with a board of directors that makes significant decisions that guide the organisation. A corporation can be controlled by a single person, especially at its birth, but as it grows, so does the necessity to administer it as a board-directed body. The regulations established for larger organisations, such as maintaining notes on every key decision that affects the company, nonetheless apply to a small enterprise.

6. Capital investment

If you need outside finance, such as from an investor, venture capitalist, or bank, forming a corporation may be a preferable option. Corporations can receive outside investment more easily than sole proprietorships.

Corporations can sell stock and gain more cash for expansion, but sole proprietors can only obtain funds from personal accounts, using personal credit, or bringing on partners. An LLC may encounter comparable difficulties, but because it is its own business, it is not necessarily essential for the owner to use personal credit or assets.

7. Licenses, permits and regulations

You may require particular licences and permits to operate in addition to officially registering your business entity. Depending on the nature of the firm and its operations, it may be necessary to obtain licences at the local, state, and federal levels.

“States have varying criteria for various business forms,” Friedman explained. “There may be varying restrictions at the municipal level depending on where you start your shop. Understand the state and industry you’re in when you choose your structure. It is not a one-size-fits-all solution, and firms may be unaware of what is pertinent to them.”

The structures presented here are solely applicable to for-profit companies. If you’ve done your study and are still unclear about which business structure is best for you, Friedman recommends meeting with a business law specialist.

Advantages of this business structure include

  • Liability is limited. Stockholders are only liable for their personal investments and are not personally liable for claims against your corporation.
  • Consistency. Corporations are unaffected by death or the transfer of shares by its shareholders. Your company operates indefinitely, which is preferred by investors, creditors, and customers.
  • Funding. When your company is formed, it is considerably easier to raise huge amounts of funds from various investors.
    Rather than a startup based in a living room, this form of business is suitable for companies that are further along in their growth. For example, if you’ve already named your company, selected directors, and raised funds through shareholders, the next step is to incorporate. You’re effectively conducting business at a higher risk-to-reward ratio. Additionally, your company could file as a S corporation to take advantage of the tax advantages that come with it.

Examples of corporations

When your company reaches a particular size, it’s probably in your best interest to incorporate it. There are numerous well-known examples of corporations, such as:

Rather than a startup based in a living room, this form of business is suitable for companies that are further along in their growth. For example, if you’ve already named your company, selected directors, and raised funds through shareholders, the next step is to incorporate. You’re effectively conducting business at a higher risk-to-reward ratio. Additionally, your company could file as a S corporation to take advantage of the tax advantages that come with it.

  • General Motors
  • Amazon
  • Exxon Mobil
  • Domino’s Pizza
  • Morgan Chase

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