Choosing the Right Business Structure for Your Small Business Startup

Before starting a small business, one of your first decisions will be choosing the right business structure. You have a number of options, including sole proprietorship, partnership, C corporation, S Corporation, and limited liability company. Which you choose will depend on a number of factors, including cost, taxes, liability concerns, and financial structure. Here are some of the pros and cons of different business structures for your small business startup.

Sole Proprietorship. If your small business is likely to be a one-man show and simplicity of structure is important to you, a sole proprietorship may be the way to go. It is the easiest and least expensive business structure for a startup, since the business and the owner are the same. If you structure your business as a sole proprietorship, you will be personally responsible for the business's liabilities and its income or losses will flow directly to you for tax purposes.

Partnership. In some ways, a business partnership is much like a sole proprietorship with multiple owners. As with a sole proprietorship, partners are personally responsible for the partnership's liabilities and its income and losses flow through to them for tax purposes. However, a partnership is more complex, since ownership and control of the business is in the hands of two or more partners, which can make the decision-making process more cumbersome. Also, partners have joint liability, meaning each partner is liable for actions taken by other partners, such as contracts signed or debt incurred.

C Corporation. A C corporation is a legal entity separate from the individual or individuals who started the business and the management team. Corporations can be expensive to start, given state filing and other regulatory and reporting requirements. Shareholders typically are not liable for the corporation's debts and other liabilities. Taxation is at the corporate level, although, if the corporation distributes after-tax income to shareholders as dividends, their dividend income is subject to taxation at the personal level, resulting in double taxation. Advantages of the corporate structure include the ability to raise capital by selling shares and the easy transfer of shares. Also, a corporation can survive the death or departure of shareholders, unlike a sole proprietorship, which is dependent on its owner to continue.

S Corporation. The biggest difference between an S corporation and a C corporation is that an S corporation passes corporate income and losses through to its shareholders, who report them on their personal income tax returns. There are other differences, such as some limitations on S corporation stock transfers and stock ownership, but S corporations are subject to many of the same regulations as C corporations.

Limited Liability Company (LLC). A limited liability company is a hybrid business structure. It is similar to a corporation in that its owners' personal liability for the LLC's debts and actions is limited, but it is similar a partnership in that its income passes through to individual owners (usually called members) for tax purposes. However, an LLC is not a corporation. Instead, it is a type of unincorporated association, and it does not have to be for profit.

Which business structure you choose for your small business startup will depend on your goals for the business. If you plan to run the business yourself, are not concerned that it survive you and want a simple, low-cost structure, a sole proprietorship makes sense. If, on the other hand, you need to raise startup capital from outside investors, plan to take the company public in the future, and are concerned that it can continue when you are gone, a corporation may be the better choice. Remember, a business's structure is not set in stone. For example, a sole proprietorship or partnership can incorporate if, at some point, you decide that the corporate structure is preferable. If you are uncertain which business structure to select, you might want to talk to a business consultant, an attorney who specializes in business law and/or your accountant to help you understand the advantages and disadvantages of each for your small business startup.

Sources:

www.sos.state.ia.us, Sole Proprietorship

www.irs.gov/businesses/small, S Corporations

www.irs.gov/businesses/smal, Limited Liability Company (LLC)

en.wikipedia.org, Limited liability company - Wikipedia, the free encyclopedia