03/ 27/ 2006
by Steve Strauss
What is the best way to structure your small business? You have four options: a sole proprietorship, a partnership, some type of corporation or a limited liability company (LLC).
Sole proprietorships: A sole proprietorship is the easiest and cheapest form of business you can start. Simply name the business, get a business license, publish a fictitious business name statement in the local paper, and you are in business. It should cost about $100 to start a sole proprietorship. Although sole proprietorships are inexpensive and easy to create, the bad news is that you and the business are one in the same; if something goes wrong, you are personally liable.
Partnerships: A business partnership is akin to a marriage. Because partners will be spending a lot of time together in good times and bad and making joint and individual decisions that will affect the partnership, you need to think very carefully about whether you actually want a partner, and if so, who.
In a partnership, as in a sole proprietorship, you become personally liable for business debts and liabilities. Moreover, because either partner can get the partnership into debt, your potential liability doubles. If your partner makes some poor decisions that get the partnership into debt, for example, you will be personally responsible for that debt.
You must also think about the emotional aspect of having a partner. Do you really want one? Are you able to share authority? As a sole proprietor, you are the boss, but having a partner means you will have a partner. And remember, partnerships do not always work out. Best friends who become partners do not always stay best friends. On the other hand, a partner gives you someone with whom to work, share ideas and brainstorm. Also, a partner provides another pair of hands to do the work.
It’s important to weigh carefully the pros and cons of having a partner. Then, if you decide that the benefits outweigh the burdens, find someone with whom you can work well.
Corporations and limited liability companies (LLCs): As you can see, the problem with partnerships and sole proprietorships is the personal liability that comes with those business forms. These entities do not protect you from business debts. But corporations and LLCs are different. In fact, one of the chief reasons to incorporate is to legally shelter your personal assets from business debts.
There are several types of corporations. The main two are the S and C corporation (S and C are subsections of the IRS Code.). Differences between the S and C corporations are:
- C corporations are taxed twice: when profits are realized and when those profits are passed onto the shareholders. S corporations pay no corporate taxes. Instead, profits and losses flow through to individual tax returns.
- C corporations are often large, publicly traded businesses. They are businesses whose shares are bought and sold on the NASDAQ. The ability to freely sell shares is one of the main advantages of a C corporation. S corporations are, generally speaking, intended for and used by smaller businesses.
Limited liability companies (or LLCs) are a hybrid, combining the best of corporations, sole proprietorships and partnerships and have become very popular. First, LLCs protect their owners from being personally liable for business debt. Second, LLCs are fairly informal. They are easy to create, inexpensive (the filing fee with your state will likely be less than if you started a corporation) and can be formed with only one member (unlike a corporation that requires officers and a board of directors.)
Which type of business structure is best for you? The best answer is to discuss these options with your legal and tax advisors before making that decision.
