Every successful business starts with a great idea. But in order to bring that idea to fruition, the first step in forming your business is choosing a structure that best fits your needs. There are myriad business types to choose from, and every structure has its pros and cons, thus the most important considerations in choosing an entity type are: personal liability, tax considerations, and management structure. Below, we highlight the most common business structures and the considerations of each.
A sole proprietorship is defined as an individual owning an unincorporated business by her- or himself. This business structure – or lack thereof - is much simpler and quicker to form and doesn’t typically require any state filings with dues or fees. A sole proprietor has the most freedom in terms of management structure since she or he is the sole owner and thus inseparable from the business. With that being said, a sole proprietor is also “on the hook” personally for all of the business’s debts and obligations, so personal assets are reachable by creditors. The income from the sole proprietor’s business is treated as personal income, so the business itself is not taxed separately. Many people find it helpful to start as a sole proprietorship and change to an LLC or S-Corporation after they’ve decided to scale the business more.
A partnership is formed when two or more individuals join together to carry on a business for-profit as co-owners. Many states vary on the requirement of state filings, but most require that you register your business name and obtain a state ID number. Often times close friends and family members will decide to go into business together, so they form a general partnership. A general partnership operates structurally similar to a sole proprietorship, just with the addition of at least one more person to the business. Partners will share profits and losses amongst each other, and each partner is also personally liable for any taxes, lawsuits, or liabilities incurred by the business. Finally, partners are generally responsible for reporting income and losses on their own individual tax return. Partnerships, like sole proprietorships, are less burdensome to form and provide you with the advantage of having another person’s knowledge and skillset to collaborate with.
Limited Liability Company (LLC)
An LLC is most typically described as having the tax benefits of a partnership/sole proprietorship, but the limited personal liability of a corporation (which is why it tends to be the most popular). An LLC still maintains flexibility in management structure, but also creates a separation from the individual owner(s) and the business. There are also more formalities involved with an LLC, such as state filings (and a fee) with your state’s respective Secretary of State, along with annual reports in some states. While not always required, Operating Agreements (or Owner’s Agreements) are essential to LLCs in maintaining limited personal liability, as this protection is not automatic and requires the observance of certain formalities. [Read more about Operating Agreements here] While LLCs require more paperwork to get started, they do offer a “best of both worlds” scenario to certain businesses.
An S Corp is another hybrid business entity which combines the tax benefits of a partnership/sole proprietorship, but also limits personal liability and permits the owners to actually own stock of the business. The management structure of an S Corp is a bit more complex and includes shareholders, the election of a board of directors, and appointment of officers. S Corps require state filings for formation, but unlike an LLC, S Corps are also required to file Articles of Incorporation and corporate minutes with their respective states. Another defining feature of the S Corp is that it must pay a reasonable salary to all shareholders and officers/employees, whether or not the business is profitable. S Corps tend to be more appealing to small businesses looking to scale to the next level, as investors are more drawn to this structure due to the ability to sell or transfer stock.
Corporation (C Corp)
A corporation (also known as a C-Corp) is a business structure that can be comprised of individuals or even different companies and limits personal liability. Corporations are unique in that they are a separate entity from their owners. This type of business structure requires shareholders, a board of directors, and officers. Corporations can be publicly-traded companies and sometimes have access to larger investors. Stricter formalities are required of corporations, such as filing of Articles of Incorporation, Bylaws, corporate minutes, formal board meetings, stock distribution reporting, etc. C Corps are subject to double taxation, which means the shareholders (owners) are taxed on the salary they are paid and the business is taxed on its profits. Corporations are best for much larger scale businesses looking to grow or eventually go public.
Regardless of whatever structure you think is best for you, it is always advisable to consult an attorney and CPA to determine which is most suitable for you. If you’re looking to form your business in Connecticut or Massachusetts, you can contact us at: firstname.lastname@example.org or 860-552-7770.