When you’re starting out on the road to owning your own business, you have many important decisions to make. But you can’t attract investors, open a bank account or apply for a small business loan until you choose your business structure. Here are some advantages and disadvantages of different business structures.
Sole Proprietorships: The most common and simplest form of business formation is a sole proprietorship. The business is owned and managed by an individual proprietor. It’s easy to form with less paperwork than other structures; the owner also pays taxes on income from the business as part of his or her personal income tax payments. Downside: The proprietor is personally responsible for all debts and liabilities incurred by the business. In addition, sole proprietorships are considered a risky investment and attracting investors may be more difficult.
Partnerships: There are two types of partnerships: General Partnerships and Limited Partnerships. General partnerships have two or more partners and all of the partners manage and are responsible for the business’s debts and operations. Limited partnerships have both general partners and limited partners; the limited partners are investors and not liable for the same day-to-day responsibilities as the general partners. Partnerships are easy to form, and the business does not pay tax on the company’s income; instead, all profits and losses are passed through to the partners. The downside is the same as a sole proprietorship: The personal liability for all the businesses obligations and debts falls to the partners. In a limited partnership, however, a limited partner’s liability for the partnership’s debt is limited to the amount of money or property that individual partner contributed to the partnership.
C Corporations: C corporations are the most costly and most difficult to form in terms of regulations and paperwork, but because the C corp is considered a complete separate entity, owners and shareholders are not held responsible for any of the corporation’s debts or lawsuits brought against the company. A corporation can also sell stock or shares, and if you ever plan to go public, you must be a C corp. Other advantages include being able to provide an employee stock sharing plan and to split profits and losses between the business and the owners to create an overall lower tax rate. Downsides include more paperwork and costs due to state and federal filing fees and possible double taxation on earnings and dividends.
Limited Liability Company (LLC): An LLC has some requirements of a corporation and some elements of a partnership/sole proprietorship. It protects owners and shareholders from personal liability in case of judgment or debt. Although an LLC must file articles of organization with the state, it’s a more flexible management structure than a corporation. Also, an LLC can choose whether or not it wants to be taxed as a sole proprietorship, partnership, S corp or C corp. Although LLCs do not deal with “double taxation,” they do incur “pass through” taxation in that profits and losses are reported on each owner’s individual tax return.
Rieva Lesonsky is CEO of GrowBiz Media, a media and custom content company focusing on small business and entrepreneurship. Email Rieva at firstname.lastname@example.org, follow her on Google+ and Twitter.com/Rieva and visit her website, SmallBizDaily.com, to get the scoop on business trends and sign up for Rieva’s free TrendCast reports.