How to Choose the Right Business Legal Structure for your Startup

Your business’s legal structure has lots of meaning when it comes to determining how much liability it’ll face during lawsuits. It can either put a barrier between your business and personal taxes or ensure the barrier doesn’t exist.

When launching a new business, it’s always important to make a choice about your business structure. Your choice will even strongly affect what your business name is going to be about. Also, the legal and tax implications you’ll deal with as well.

In this article, we’ll dive deeper into learning more about business structures and which one is the right fit for you.

What are the business structures that exist?

Before we go any further into this article, we’ll start to learn more about the types of business legal structures that exist:

Sole Proprietorship

This is the most simple business structure. The last study conducted showed that around 29 million individuals started a sole proprietorship. The costs of this business structure depend on the market you are in. Good examples of this business type are freelancers, accountants, online tutors, etc.

With this business legal structure, you have many advantages:

1. They are easy to set up: We can undoubtedly say that it’s the easiest to start. You don’t have to ask for approval from anybody and don’t have to deal with too much paperwork.
2. Low costs: Costs will vary based on where you live, but most of the time, you’ll only be dealing with business taxes and license fees.
3. Tax deductions: Since your business is considered a legal entity, you might be eligible for tax deductions.
4. Easy exit: You are your own boss, so this means you can leave your business anytime you want, without needing to file any formal paperwork.

The only downside of this business is that you are accountable for everything that happens to it.

Partnership

Partnerships are owned by two or more people. They can either be general or limited. Limited partnerships only allow one person to control the business's operations, while the other only receives the profits.

This business structure has several advantages:

1. Easy formation: Will require you to obtain a business license and certificate claiming your partnership agreement. However, the partnership agreement you need to obtain will depend on where you live.
2. Lots of growth potential: When looking for funding opportunities, you have an advantage since you aren’t alone, or you can separate duties, and in most cases, two are greater than one.
3. Special taxation requirements: This applies to general partnerships, which require you to file a Federal Tax Form 1065, but won’t require you to pay income tax.

Partnerships are a great choice if you find the right person to do business with and the good side is that you share duties if you agree on a general partnership.

Limited Liability Company (LLC)

An LLC is a business legal structure that allows business owners, partners, or shareholders to have limited personal liabilities by enjoying partnership taxes and many other benefits. This type of business can get you out of a lot of trouble if it were to fail since you are sharing liabilities.

Forming an LLC will depend on where you live since costs differ from state to state. Some popular LLC companies include: eBay, Nike, Sony, and Pepsi.

Corporation

Corporation filing will depend on state-to-state and fee categories. There isn’t only one form of corporation, but several of them:

1. C corporations: These types of corporations are taxed by separate entities. The good side of a C corporation is for companies that are looking to raise funds and go public. However, keep in mind that you’ll be dealing with double taxation and strict regulations.
2. S corporations: The best option for small businesses. They don’t have to deal with double taxation like C Corporations, LLCs, and partnerships. Also, owners of S corporations have limited liability protection.
3. B corporations: These types of corporations aren’t mentioned too frequently. They are called ‘’benefit corporations’’ and are created to positively contribute to society.
4. Closed corporations: These are run by a small number of shareholders, aren't available for public trade, and benefit from limited liability protection.
5. Open corporations: Are available for trade on a public market. Companies like Microsoft are open corporations. They allow anybody to invest and take ownership.
6. Non-profit corporations: The world itself shows you that these types of corporations are rewarded by tax exemption. They aren’t focused on making a profit but only focus on a certain task.

Corporations have many advantages like limited liability, capital, and continuity. However, if you are someone that wants more ownership, and doesn’t like taxes, corporations might not be the right choice for you.

The importance of choosing a business legal structure

A business legal structure is also known as a business entity. At a federal level, your business legal structure will show you how much taxes you need to pay. At a state level, it will show you your business liability level.

That being said, let’s now take a look at the factors you need to consider when choosing the right business structure:

1. Taxes: The amount of taxes you pay will strongly depend on your business structure. Let’s just say, that the larger the business structure, the more taxes you’ll be paying.
2. Amount of paperwork: Each business legal structure has different tax forms. Also, different levels of paperwork you need to complete so this will initially depend on which choice you go with.
3. Hierarchy: All business legal structures except corporations don’t have a hierarchy. Corporations have a board of directors, and these hierarchies prevent the business from closing if the founder passes away or decides to exit the company.
4. Registration: A business legal structure is obligatory for allowing you to register your business in your area. If you don’t have one, you won’t be eligible for an employer identification number (EIN) or able to acquire the necessary business licenses and permits.
5. Fundraising: Depending on which business structure you choose, this will dictate if you can raise funds or not. For instance, corporations can offer stocks, while sole proprietorships can’t.

Choosing the wrong business structure can have lots of consequences for your business in the future. Therefore, it’s important to carefully analyze all the information provided and choose the right one, because if you don’t, the process can get complicated and might even lead to tax consequences.

Factors you need to pay close attention to when choosing your business legal structure

As you are starting to choose which business legal structure is the right fit for you, here are three important factors you need to pay close attention to before making your final decision.

Balancing out liability protection and the complexity of the structure

Many business owners will start on their own only because of the simplicity and few compliance requirements it has. However, starting a business on your own also means you have all the accountability on your shoulders and this puts your business at risk if you were to make bad decisions.

Moreover, if you are someone who doesn’t like liability, your best option would be to form an LLC. This type of business structure shields your assets and doesn’t have much paperwork and compliance requirements.

Finally, if you fear risk and hold too much liability, you could form a corporation. We mentioned that there are different types of corporations, and the good news is that you have more protection on your assets from debts, and court rulings against your business. However, if you don’t like taxes and sharing equity with others, this isn’t the right choice for you.

Finding the right tax treatment

If you are running a sole proprietorship, your business profits will be taxed on an individual level, and this is a personal income tax form. However, this business structure doesn’t face large taxes like a corporation would.

C corporations, on the other hand, double-tax your business profits. This means that the taxes you pay are taxed at the business tax rate and through the shareholder dividends. However, if you are considering running a corporation that has tax flexibility, you can always turn your attention to S corporations. S corporations have the same tax treatment as LLCs.

Potential growth

LLCs and sole proprietorships don’t allow you to sell company stock. This means that if you choose these business structures, you won’t be able to generate funds to grow your business. However, with an S and C corporation, you can sell shares of stock to fund your business.

S Corporations are more limited compared to a C corporation, since they have a limited number of shareholders to 100 or less, and might only offer you one class of stock.

C corporations, on the other hand, offer lots of opportunities when it comes to growing your business, and have no limit on how many shareholders you can have.

It’s now time to make your decision

You’ve got a chance to learn about what type of business legal structures exist, the importance of choosing one, and what factors will impact your decision making process. Now, it’s time to carefully choose the right choice for you after you’ve decided what your business requirements are.

Are you someone who wants to take full control of your business? Or would you like to share liability with another person? Or, maybe you are someone who likes to run a business that has an easy exit plan. It’s now time to make your choice and start a new business!