Starting a business requires prospective entrepreneurs to make hundreds of different decisions before opening their doors to customers. One of the most important decisions is selecting the right legal structure for your enterprise. The manner in which you choose to organize will impact your taxes, personal liability exposure, and fundraising options.
Sole proprietorships are the most common arrangement for people who work alone. This structure is a popular choice because it is the easiest to arrange and does not require any filings with the state. One of the biggest disadvantages of the sole proprietorship, however, is that entity does not exist apart from the owner. Consequently, the owner is personally liable for all financial obligations and damages resulting from lawsuits filed against the company. Another disadvantage is that it can be difficult to raise capital. Banks are reluctant to make loans to sole proprietorships, leaving the owners to rely on home equity loans or borrowing from family.
For enterprises with more than one owner, a partnership might be a good arrangement. Each partner contributes capital, labor, or expertise in order to turn a profit. The partners share in the profits, but like a sole proprietorship, they are also personally liable for debts and damages. One way in which partners can reduce personal exposure is by forming a limited partnership. This form consists of general partners who make decisions and assume the risks and limited partners with no control in the operations in exchange for reduced liability. Tax treatment is one of the main reasons this arrangement is selected. Profits and losses are passed through to the individual partners.
Limited Liability Companies, or LLCs, are a type of structure that is becoming very popular. This structure creates an entity separate from the owners. As a result, the owners are not liable for debts or judgments against the venture. Unlike a limited partnership, all members are free to participate in the management and enjoy protection from personal liability. LLCs also enjoy pass through taxation. However, the tax rules for these structures are complicated. The amount of paperwork is a huge hurdle, and members must file articles of organization with the Secretary of State or sign an operating agreement.
The right structure for your business depends on a number of different factors unique to your enterprise. For example, a small boutique selling handmade cat collars will obviously have less risk and perhaps less revenue than a company that provides window washing services to high-rise office buildings. Prospective entrepreneurs are advised to contact their attorney or accountant in order to discuss the taxation and liability consequences of the different entities. A number of free or low-cost resources to help you make your decision are available from your local chamber of commerce, Small Business Administration, or volunteers with the Service Corps of Retired Executives.
Selecting the organization for your business is one of the most important decisions you and your partners will make. Research all of the available options and seek advice from experienced professionals before making your selection.