Updated: Jan 11, 2020
For businesses just starting out it is essential for them to have a strong understanding of business entity and structure. Here we will tell you what a business structure is, why its important, and give you some pro tips to use when structuring your business.
What is a business structure?
Business structure is the way you decide to legally file and organize your business. You are given the option to run your business as a Sole Proprietor, LLC, LLP, or a Corporation. This is a big decision to make and requires consultation with business experts as well as a lot of research on your part. In this business article, we will discuss why structuring is important, what structuring effects, talk about all the business entities and provide professional tips to implement when its time to structure your business.
Why is structuring your business important?
Structuring your business will impact your year to year operations. It affects how you file your taxes, your ability to crowdfund, your liability and asset protection, as well as dictates how much annual paperwork is required to stay in business.
Sole Proprietorship - Sole Proprietorship is by far the most popular business structure in
the USA with over 23 million businesses structured this way. By definition, a sole proprietorship is a type of enterprise that is owned and run by one person and in which there is no legal distinction between the owner and the business entity
Advantages of a sole proprietorship: Fast to start, easy + inexpensive to maintain, easier tax reporting, privacy within your business, minimal reporting requirements, more control over your business, in most cases you can still get limited liability insurance as a sole proprietor
Disadvantages of a sole proprietorship: Unlimited personal liability. You are responsible for all outstanding debts and lawsuit payouts for your business, no business write-offs, difficulty getting investment money from banks or private investors
LLC - otherwise known as Limited Liability Company. Structuring your business this way offers limited liability protection to the business owners. This structure offers a limited separation of personal and business assets. For example, let's say a customer was injured by your product or while visiting your store. Having an LLC means the plaintiff can only go after your companies assets and not your personal assets. If you were a sole proprietor a lawsuit like that could kill your business. Most people move from a sole proprietor to an LLC when they are still in the early stages of the company and seeing enough business assets to protect. As their business grows in assets and revenue, usually people restructure as a corporation which offers more protection. Continue reading to learn more.
Advantages of an LLC: Offers limited liability protection, flexible structure, easy to form and maintain, can have any number of members with no restrictions on their pay.
Disadvantages of an LLC: Self-employment tax, more annual forms, difficult to raise start-up funds
LLP: otherwise known as Limited Liability Partnership; before the year 2000 limited liability protection was only offered to companies. That all changed when LLPs were introduced in the Partnership Act 2000 which granted business partnerships with the same limited liability protection as LLCs. Professional Partners may independently draft a contract that lays out the terms of their arrangements which offers a lot of freedom. Many professions have LLPs as the preferred business structure, most notable firms such as accounting firms or law firms.
Advantages of LLP: LLPs are a separate legal entity to the members which offers limited liability protection, an LLP is considered a legal single entity or person therefor you can open business credit without affecting your personal credit limit, LLP's allows for corporate ownership, you can operate an LLP at different levels of membership, LLP's still allow a lot of flexibility.
Disadvantage of LLP: all income is taxed as personal income ( there may be some tax benefits as a company but it boils down to your tax preferences ), financial accounts need to be kept public record, profit can not be retained in the same manner companies can rollover profits on a year to year basis, must have at least 2 members.
Corporation- A corporation is a legal business entity that trades partial ownership of the company (stock) through shares. When running a corporation you must at all times be running the business for the benefit of your investors. There can be private and public corporations that dictate who may buy stock. As a summary, a corporation is a single business entity run by several members with a collective goal which is usually to produce the highest amount of profits for net returns.
Advantages: Liability protection is a huge advantage because in nearly all cases the owners are not liable for any debt or legal judgment of a corporation. Another huge benefit is the ease of funding. This business structure makes it the easiest to gain capital. A corporation doesn't die. Once an owner, even the majority holder who founded the company, dies or decides its time to step down they simply dissolve their shares and relinquish ownership rights. There are also tax benefits as the corporation's taxes are independent to your personal taxes. Disadvantages: Double taxation. Once you have finished your corporate taxes you still have to file individual taxes for shareholders. Double taxation can only be avoided with S corporations. Tremendous paperwork is involved in maintaining a corporation. There are lots of restrictions such as conflicts of interest. You don't have autonomy over your company once you have a board of directors. Meticulous record-keeping
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