A great idea is key to any successful business, but there is more to success than just that great idea. Your choice of business structure can also affect the business trajectory, especially if your plans include long-term growth.
Limited liability company, partnership, corporation, or sole proprietorship? Which is best? What tax elections should be made? Sub S treatment, disregarded entity? You want to make sure your business structure fits your business goals, offers proper protections and clearly delineates how you and your co-investors will operate together. Accordingly, determining the proper structure requires an attorney’s understanding of those goals, type of product or services involved, potential profitability and the characteristics of the players in order that proper documents are executed. See this primer on various business structures – and ways your choice of structure will affect you and your business.
1 – LIABILITY
The sad truth is – Businesses do not always succeed. Although your idea may be brilliant, there are myriad variables impacting success that no one can foresee. Depending on your choice of business structure, or more certainly if no official legal entity is formed, there is a chance that if your business fails, it could also impact your personal wealth and personal life.
Most small businesses operate as sole proprietorships. A sole proprietorship is the simplest type of business structure, but it offers little legal separation between you and your business. Under this simplest business structure, debts and lawsuits can impose on your personal estate. As a result, many people choose more complex structures to limit their personal liability.
2 – TAXES
Business structures encompass various types of tax filing arrangements to best suit parochial requirements. In some business structures, owners must personally pay tax on all profits of the business. In an improper arrangement, owners may pay taxes twice. Once on the profits of the business at the corporate level, then again personally on dividends received. Another issue, some tax elections lead to high accounting overhead. For these reasons, amongst others, the choice of a business structure must incorporate tax matters research.
3 – PAPERWORK
Once a business structure is chosen, the entity must register with the Secretary of State. Then corporate formalities must be undertaken to maintain legal recognition of the entity. The choice of business structure affects how much record-keeping must be completed each year.
Many people chose simpler business structures, such as sole proprietorships, limited liability companies and partnerships, largely to avoid the extra paperwork corporations require. None-the-less, it is important to formalize roles and responsibilities of owners and investors even in these simpler arrangements. Partnership agreements, operating agreements, buy-sell, non-compete documents and the like should be drafted and executed. Properly drafted they will include manner of voting, what happens if an owner leaves, liability protections against creditors and so on. This prevents things such as when one partner’s sudden life changes negatively impacts the business. Consequently, organizational documents reflecting business structure choice should also address concerns like investor disagreements and succession planning.
4 – INVESTORS
Many business owners make the same common mistake. They choose their business structure based only on their present concerns when they get started. Neglecting a structure that will best help them meet their evolving goals.
If a business plan involves the sort of growth that could attract and benefit from future additional investors, a business structure should be chosen that can better attract those investors. As others have noted, investors tend to shy away from businesses that do not offer them some reassurances. Investors will not want to pay taxes on business profits if they are not receiving some sort of distributions. As such, most investors prefer the corporation structure over simpler business structures.
HOW TO MAKE THE RIGHT DECISION FOR YOUR BUSINESS
No one who has done it said starting a business is easy, but it certainly can be rewarding. And choosing the right business structure can help you maximize rewards.
While you now know how your choice of business structure can affect you, you want to make sure you understand the specifics of your situation before you choose one. The right choice can help you down the road to success, so it is worth a careful review of options. Happy travels.