What good is a house without a solid foundation? Same goes for your business. No, I’m not talking about your building’s actual, physical foundation—though that’s important, too—but the business entity you decide upon for your company. Whatever you choose, the tax, legal, and operational implications will stick with your company for years.
It is hard to overstate the importance of choosing the entity that is right for your business. The various entities—sole proprietorship, partnership, limited-liability company (LLC), or corporation, each offer a different set of instruments and demand that a different set of rules to follow.
Choosing a Business Entity: Decision Time
So how do you make your choice of business entity? I’ve outlined six of the most important considerations for you, below:
Double taxation is a sore point for many companies. As a C Corporation, your company’s revenue is subject to a tax from your state and federal government, but you must also pay taxes on the personal income you bring in from the company.
An S Corporation or an LLC can avoid this entirely by being subject to pass-through taxation. Rather than impose taxes on both the corporation and the income of the owner, this allows the tax to rest entirely on income the owners and investors receive from the business. The downside, though, is that S-corp owners are subject to self employment taxes for the amount they take in salary and LLC owners who are taxed like a sole proprietor or partnership are subject to self employment taxes for the entire amount of the profit they take home.
Ability to Raise Capital
Important for any business, how you raise capital is subject to significant regulation, depending on your chosen business entity. While C Corporations offer the largest amount of flexibility, raising capital as a partnership is subject to particularly tough rules. An S Corporation provides some of the flexibility of a C Corporation, but its number of shareholders is restricted to no more than 100.
Separation of Ownership and Management
Personal liability is a huge concern for entrepreneurs. Several entities—corporations, LLCs, and limited partnerships—separate ownership from management and thus shield the business owner from suits brought against the business (barring any action that might pierce the corporate veil).
Sole proprietorships and general partnerships, on the other hand, leave the owner vulnerable to being held personally responsible for their management decisions.
Limited Liability Protection
Just as you do not want to be held personally liable for a lawsuit leveled against your business, it is essential that your personal assets remain shielded from potential business liabilities. This is often the principal reason for choosing to incorporate a business as a C Corporation, S Corporation, or LLC. Again, sole proprietorships and general partnerships do not offer this kind of asset protection.
Transferral of Ownership
Transferring ownership of a business is relatively simple in a C Corporation or an S Corporation, as that ownership is based wholly off of the shares held—the owner needs only to sell their stock to the new owner.
Other business entities do not offer the same ease of transfer. Partnerships must be terminated and sole proprietorships require that the business be sold in total to transfer ownership.
Ease of Formation
If you’ve read everything above and wondered why anyone would choose a sole proprietorship or partnership over a business entity that offers greater liability protection, the answer is easy: the process of formation and its maintenance is significantly simplified.
Sole proprietorships pose the least amount of difficulty to set up—requiring only that you register the business with the relevant agency in your state, county, and city.
All other entities must be registered through the local Secretary of State, as well as adhere to a set of recordkeeping rules to retain limited liability protections. Maintaining these records and ensuring the business remains in good standing can be costly and time-consuming, but the protection from liability might just be priceless.
What you can do
An ounce of prevention is worth a pound of cure. Whether you’re just getting your business of the ground or have seen your business through a good few years, holding off on hiring a lawyer until you think you need one could cost you. With the right help in choosing a business entity, your business may outlast you.
Hiring an experienced business lawyer in the good times allows you to set a solid framework that will allow your business to weather the bad. Just as important is the familiarity your lawyer gains with your business’s specific circumstances, allowing them to know immediately where it stands when a legal challenge arises.
If you visit our Business Set Up page, you can download our Guide for LLCs, Corporations, and Partnerships.
Your business deserves to thrive and prosper. If you are interested in learning more about legal protection strategies for your business and how we work with you as a partner in protecting your company, call us today at 612-206-3701 or reach out via our online contact form to schedule a consultation.