One of the first and most important decisions you make when starting a business is selecting the right organizational structure. The first question you have to ask yourself is “to incorporate or not to incorporate?” Deciding how to classify your business is a complex issue that can have long-standing implications. Because the needs of every business are different, and the law varies from state-to-state, it’s worth an hour or two with a knowledgeable attorney and accountant to investigate all of the issues that will affect your decision. Broadly however, there are a number of arguments that can be made on either side of incorporation.
In terms of pros, formalizing a corporate identity can help boost your business’ credibility. Additionally, incorporated businesses can sell stock or securities thereby expanding your capital-raising options. Finally, barring some exceptions, incorporation may safeguard your personal assets from liability if your company gets sued. On the flipside, time-intensive paperwork and related costs tend to deter some small business business owners in pursuing incorporation.
If you determine that incorporation is the right direction for your business, there are several alternatives to choose from:
Sole proprietorship is the simplest and most common form of business structure especially for small business owners who are in business by themselves or operating on a shoestring budget. There are no complex rules or paperwork. The main requirement is filing a certificate in the countries where the business operates. Generally, sole proprietors are personally responsible for business debts.
General partnership is similar to a sole proprietorship but is used when two or more people go into a business together. A general partnership has the same certificate filing requirements as a sole proprietorship and does not require a formal agreement between the partners. As with a sole proprietorship, you and your partners are personally liable for business obligations.
Corporations usually cross our minds when we think of large companies – and for good reason. A corporation is a more complex undertaking than a partnership or a sole proprietorship. Those with an ownership interest are shareholders and the company is normally managed by directors, though that could be circumvented through a shareholder agreement. Corporations are subject to regulations, such as keeping minutes for shareholder meetings and could be somewhat costly in fees to set up. There are two types of corporations; an “S” and “C” corporations, respectively. The main difference between the two is taxes. “S” corporations can help you get around the double taxation issue, but you have to meet specific criteria. Shareholders for “C” corporations are taxed on the company’s dividends, even though the business already paid taxes on these earnings.
The upside is that unlike in partnerships and sole proprietorships, corporations can make full deductions on health insurance premiums and shareholders have no personal liability for the company.
Limited Liability Company (LLC) is essentially a hybrid with the properties of both a corporation and a partnership. The owners of an LLC are called “members” and can manage the LLC themselves or with managers. Owners have flexibility to determine the structure, from either a general partnership with limited liability, a limited partnership where everyone is part of management with limited liability as well, or even an “S” corporation without the ownership and tax restrictions. Each entity’s liability is limited to their investment in the LLC, but the tax and other benefits are shared by all.
Pull Quote.pngThere is no right answer when it comes to incorporation. Each structure has its merits depending on the size and type of your business. For example, if you plan to engage in activities that involve a higher level of risk, like driving customers or offering financial advice, you may be more likely to consider a corporation or an LLC because of the liability protection they offer. Likewise, if you never intend to go public, or anticipate needing to issue stock for any reason, a corporation may be an unnecessary investment of time and resources. What’s most important to remember is that your initial choice of a business structure isn’t set in stone. You can start out in a sole proprietorship or partnership and later, if your business grows or the risk of personal liability increases, you can convert your business to an LLC or a corporation.
You can find a user-friendly summary of the various corporate structures here or by visiting the Small Business Administration website for more information.
