You’re excited about your start-up idea. But, you don’t know where to start when deciding what kind of business structure, or legal form it should take. Should you go with a proprietorship, a partnership, or some kind of corporate form? And then, how are you supposed to decide between the different types of partnerships and corporations? The answer: “It depends.” Here are some factors for you to consider.
Some business structures expose your personal assets to business creditors more than others. That means if your new venture is way past due in paying its bills your business creditors could come after your personal car, house and bank account to get what is owed. That can be tough on you and your family if your business hits a rough patch. That’s why many businesses are corporations.Corporations are a separate legal entities in the eyes of the law. That “separation” is what protects your personal assets from business creditors.
Formalities and Maintenance
Corporations require more formalities and maintenance than proprietorships or partnerships. These formalities involve recordkeeping and other documentation necessary to maintain business “separateness” from its shareholders. These protocols create what’s known as the “corporate veil” and is what protects your personal assets from business creditors. These formalities are really nothing more than good business practices. They are not hard to put in place, but; they do need to be consistently followed.
Separate entities, of course, need to file tax information. Depending on the type of corporation you have, your tax filing could range from a separate tax return for an S corporation to merely adding a Schedule C to your personal return if you have an LLC (limited liability company). Proprietorships represent the other end of the business tax spectrum. Since there is no separate legal entity, all revenue is income and reportable on your personal tax return. Similarly, income earned by general partnerships flows directly to each partner and is not taxed separately.
Decision Making Authority
As a proprietorship you, the owner, have 100% control of all decisions. In a partnership, multiple owners makes it easier to get more done, but decision making is fragmented and can cause to friction if there is no partnership agreement to establish healthy boundaries. Partnerships, like corporations, come in different flavors. There are general partnerships, limited partnerships, and limited liability partnerships, which in some states are only available to professionals such as doctors or lawyers because the rules of conduct that govern those professions prohibit them from operating as “corporations.” As a result, the states grants them liability protection in the form of these limited liability partnerships.
Long term financing may be more difficult for proprietorships to secure because ownership is limited to one person and if you fall ill, or are injured, your business is at risk. That would make your loan risky unless you had other assets to secure it. If financing is not a major concern, any type form of business ownership is fair game. But if you think you may want or need financing in the future, partnerships and corporations will provide more financing options.
Businesses are founded for a wide variety of reasons. Discuss you plans with your accountant and local lawyer to evaluate which business structure will best achieve your goals. Investing some time and energy up front to establish a solid foundation will contribute to your business success.