When starting a business, you’ll have your choice of several different business structures, each of which comes with advantages and disadvantages. But weighing those complex pros and cons against each other to find the “right” business structure can be difficult, even for an experienced entrepreneur.
Instead of trying to objectively find the perfect business structure, it’s often better to identify the best structure for each of several goals, then decide how those goals play into your specific business model.
Let’s start with the basics. These are the main business structures we’ll be focusing on in this article:
- Sole proprietorships. Sole proprietorships are managed and owned by a single person, who collects profits as an individual and is individually liable for anything that happens in the business. In most cases, little (if any) paperwork is required to get started.
- Partnerships are similar to sole proprietorships, but are designed for two or more people working together and splitting the profits.
- Limited liability companies (LLCs) are a separate business entity, designed to protect the owners from liability issues and in some cases, provide tax advantages. Taxes are paid by owners only when income or profits are taken from the company, and you can use a registered agent to establish and manage your LLC in a different state.
- C-corporations and S-corporations. Both C-corporations and S-corporations are separate entities, like LLCs, designed to shield owners from liability issues. However, corporations can raise money by issuing public or private shares, and any income they make is taxed. They offer more protection, but also have more rules and regulations.
Potential Goals to Consider
When creating your business, think about the importance of each of the following goals to your journey as an entrepreneur (and your business’s natural strengths and weaknesses):
- In terms of simplicity, it’s tough to beat a sole proprietorship. You won’t have to file much paperwork (if any), and you can get started immediately. You’ll file taxes as an individual, and won’t be subject to many rules or restrictions. Partnerships are a close second here. Corporations are on the other end of the spectrum; they’re burdened with paperwork, rules, and restrictions that require near-constant maintenance.
- Taxes are complicated and more subjective than the other goals on this list. In many cases, corporations bear the heaviest tax burden, since any income made by the business is taxed, and any income or profits withdrawn by shareholders are also taxed, essentially making it taxed twice. LLCs allow you more flexibility when it comes to taking taxes, since it’s a pass-through entity, but may also be subject to a corporate tax rate in some states. Sole proprietorships and partnerships are taxed simply and individually, giving you less control but, in some cases, fewer total taxes to pay.
- In terms of liability, there’s no question that corporations give you the most protection, with LLCs in a close second. These are treated as separate legal entities, so only in marginal cases could a business owner be held liable for something the business did. In a sole proprietorship or partnership, you could be held personally liable for anything that goes wrong.
- Long-term growth. Because corporations allow you to raise funds from shareholders, and have built-in structures that make it easy to expand, they offer you the most potential for long-term growth. Again, LLCs come in a close second here. Sole proprietorships and partnerships can only move as fast as their owners will allow, so they tend to grow more slowly.
- Though this point is somewhat subjective, it’s true that companies that have a formalized business structure (i.e., LLC or corporation status) tend to be taken more seriously than others. Being a sole proprietor or a partner may make you seem less professional to your prospective customers.
Other Variables to Consider
There are other variables to consider as well:
- It’s definitely possible to change your business structure as the need arises, though it can be a bit of a pain. If you don’t think you’ll be growing aggressively for a few years, you can start out as a sole proprietorship, and then upgrade to an LLC or corporation when you start to outgrow that structure.
- State rules. Each state has different rules for its LLCs and corporations. It may be in your best interest to start one of these business types in a state other than your primary residence, so evaluate the rules and regulations for each one.
- Caveats and opportunities. Some opportunities may only be available to certain business structures. For example, some businesses may prefer to only work with established LLCs or corporations.
There’s rarely a single “right” answer for what business structure you should choose, but if you know which goals are your top priorities, you should be able to choose a structure that makes sense. Consider your options carefully, and talk to peers who have already gone through the process so you can better understand it.