How to Choose the Right Legal Structure for Your Business
Published on October 24, 2022
You've got a great business idea, and now you're ready to make it happen. But before you can start turning your dream into reality, you need to choose the right legal structure or entity for your business. The wrong choice could mean costly penalties and legal headaches down the road. So how do you choose?
If you’re a new entrepreneur, this legal jargon may sound a bit intimidating, but don’t worry, it’s pretty easy to understand once you know the different legal business structures and the advantages and disadvantages of each. If you’re not sure where to begin or what kind of entity you should choose, this guide will explain your options and help you select the best one for your business.
What is a business legal structure and why is it important?
In the United States, a legal structure refers to a government classification that regulates certain aspects of your business. A legal structure determines your tax burden from a federal level while liability ramifications are possible at the state level.
The entity you choose for your business can affect everything from your day-to-day activities and how much taxes you pay, to how much personal liability you have, and how easy or difficult it is to raise money. So if you are just starting out, you’ll want to understand what the different business legal structures mean in relation to your company and its finances.
The type of business you plan to operate plays a role in the business structure you choose. You have to consider the inherent risks and liabilities that may come naturally with the industry. For example, starting a web design agency is a low-risk, low-cost business that requires little upfront investment and typically can operate with one or more people whereas, if you opened a fitness center or restaurant there are many more factors that need to be considered.
Like any other decision you make for your business, this one should be considered carefully. While you may convert to a new business structure in the future, there may be restrictions based on your location. In addition to the tax implications, there could be an unintended dissolution. In addition, state and local laws will influence the process and determine the type of licensing, permits, and registration that is required.
Put simply, you want to choose the right legal structure so that you can minimize your liability and maximize your profits. Keep reading to learn about the different types of business structures you can choose from and what steps you can take to help you make your decision.
Four Common Business Structures
There are four main types of business structures in the United States: sole proprietorships, partnerships, limited liability companies (LLCs), and corporations. Here’s more information about each legal structure, their pros and cons and examples of businesses that operate within that type of entity.
1. Sole Proprietorship
A sole proprietorship is the most basic type of business structure. It’s a business owned and operated by one person. This structure is simple and easy to set up, and it offers complete control and decision-making power to the owner. Sole proprietorships can be a good choice for people looking to open low-risk businesses, as well as people who want to explore a business idea and see if it is a good match before jumping in with both feet. In fact, there are over 23 million sole proprietorships currently operating in the United States, making it by far the most popular form of business entity (source). A few examples of businesses that could be run as a sole proprietorship include: a web designer, online business directory owner, freelance writer, a house cleaning service, or a dog-walking business.
Pros:
Cons:
Here’s a tip: A majority of SiteSwan Website Resellers choose to operate their web design agency as a sole proprietorship because of the feasibility as well as all the other pros listed above.
2. Partnership
Do you have a friend or maybe a spouse that you’re considering going into business with? Partnerships are a popular business structure because they offer many benefits, including the sharing of management duties, financial resources, and profits. Plus, it’s not required to file paperwork with the state to establish a partnership. Typically, a legal document known as a written partnership agreement will be created to outline the responsibilities and level of ownership for each party. When it comes to filing taxes, each partner files respectively under their own name. Some examples of businesses that can be run as partnerships include: accounting groups, law firms, real estate investment firms, and physician groups.
Pros:
Cons:
3. Limited Liability (LLC)
A limited liability company (LLC) is another popular business entity option. Some of the most well-known brands including Nike, Mobile, eBay, IBM and Sony operate as an LLC. This type of business structure combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. This means that the owners are not personally liable for the debts and liabilities of the LLC. An LLC can be formed by one or more individuals, corporations, or other LLCs. If you are looking for a business legal structure that will give you limited personal liability, an LLC may be a good choice.
Pros:
Cons:
4. Corporation
A corporation is a legal entity that is separate and distinct from its owners. Corporations can be either for-profit or nonprofit. Any big company you can think of is most likely a corporation. For example, Coca-cola Company, Apple, Google, Microsoft, J.P Morgan Chase, and Toyota all operate as corporations. The main advantage of incorporating is that it limits the liability of the owners. This means that if the corporation goes bankrupt, the owners will not be held personally liable for the debts of the corporation.
Under the corporation pillar there are two primary options, C Corporation and S Corporation.
C Corporation: C corporations offer several advantages, including limited liability protection and the ability to raise capital through the sale of stock. However, C corporations also have some disadvantages, such as double taxation of profits. When choosing a business legal structure, it's important to consider your company's size, ownership structure, and financial needs.
S Corporation: A S corporation is a business entity that’s separate from its owners, has shareholders, and pays taxes on its income. S corporations are advantageous because they offer limited liability protection to their shareholders. This means that if the company is sued, the shareholders will not be held personally liable for damages. S corporations also have the ability to pass income through to their shareholders, which can save on taxes. Finally, S corporations tend to be more attractive to investors than other business entities.
Pros:
Cons:
Tips to Help You Choose Which Entity is Right for Your Business
Now that you are familiar with the different types of legal structures, you may have an idea of which entity you want to choose for your business. But, you want to feel comfortable and confident in your selection to help give you that peace of mind that you’re making the best choice. Before you make a final decision, consider taking these next steps:
In Conclusion…
Choosing which business entity you want to operate under is an important decision to make. The first step is to do your research. Understand your options and know the industry. You also need to identify your business goals and assets, and the liability you’re willing to risk.
Keep in mind that the legal structure you choose will have implications for how you operate your business, so it's important to choose carefully. The extra time you put into doing your research will be well worth it when you have your business structure solidified, setup and running. If you’re ready to take the next step, you can use a platform like LegalZoom to help you through the process of setting up your business entity and creating the legal documentation you may need for your new business venture.
As you can see, starting a business and choosing a legal structure can actually be quite easy. If you’re interested in starting your own business but are still shuffling through your options, consider launching a web design business with SiteSwan. There’s no technical experience required, and you’ll get all the resources and tools you need to run your business so you can start building and selling websites in no time. Get started today!
You've got a great business idea, and now you're ready to make it happen. But before you can start turning your dream into reality, you need to choose the right legal structure or entity for your business. The wrong choice could mean costly penalties and legal headaches down the road. So how do you choose?
If you’re a new entrepreneur, this legal jargon may sound a bit intimidating, but don’t worry, it’s pretty easy to understand once you know the different legal business structures and the advantages and disadvantages of each. If you’re not sure where to begin or what kind of entity you should choose, this guide will explain your options and help you select the best one for your business.
What is a business legal structure and why is it important?
In the United States, a legal structure refers to a government classification that regulates certain aspects of your business. A legal structure determines your tax burden from a federal level while liability ramifications are possible at the state level.
The entity you choose for your business can affect everything from your day-to-day activities and how much taxes you pay, to how much personal liability you have, and how easy or difficult it is to raise money. So if you are just starting out, you’ll want to understand what the different business legal structures mean in relation to your company and its finances.
The type of business you plan to operate plays a role in the business structure you choose. You have to consider the inherent risks and liabilities that may come naturally with the industry. For example, starting a web design agency is a low-risk, low-cost business that requires little upfront investment and typically can operate with one or more people whereas, if you opened a fitness center or restaurant there are many more factors that need to be considered.
Like any other decision you make for your business, this one should be considered carefully. While you may convert to a new business structure in the future, there may be restrictions based on your location. In addition to the tax implications, there could be an unintended dissolution. In addition, state and local laws will influence the process and determine the type of licensing, permits, and registration that is required.
Put simply, you want to choose the right legal structure so that you can minimize your liability and maximize your profits. Keep reading to learn about the different types of business structures you can choose from and what steps you can take to help you make your decision.
Four Common Business Structures
There are four main types of business structures in the United States: sole proprietorships, partnerships, limited liability companies (LLCs), and corporations. Here’s more information about each legal structure, their pros and cons and examples of businesses that operate within that type of entity.
1. Sole Proprietorship
A sole proprietorship is the most basic type of business structure. It’s a business owned and operated by one person. This structure is simple and easy to set up, and it offers complete control and decision-making power to the owner. Sole proprietorships can be a good choice for people looking to open low-risk businesses, as well as people who want to explore a business idea and see if it is a good match before jumping in with both feet. In fact, there are over 23 million sole proprietorships currently operating in the United States, making it by far the most popular form of business entity (source). A few examples of businesses that could be run as a sole proprietorship include: a web designer, online business directory owner, freelance writer, a house cleaning service, or a dog-walking business.
Pros:
- Easy to establish: You don't have to file any special paperwork with the government, and you can get started right away.
- Tax deductions: You have complete control over business decisions, and can enjoy many tax advantages.
- Low cost: Requires a minimal upfront expense to start your business.
- Simple exit: Closing a sole proprietorship is as easy as ceasing operations and tying up loose ends.
- Flexibility: You’re not subject to the same regulations as other business structures. This means that sole proprietors can operate with less paperwork and compliance requirements.
Cons:
- You’re liable for all debts: You are responsible for all debts and liabilities incurred by the business. This means that your personal assets could be at risk if your business is sued or collects debt. Your liability is unlimited with this type of business entity.
- It can be a challenge to raise money: It can be difficult to raise money from investors or get loans from banks because they view you as a high-risk investment.
Here’s a tip: A majority of SiteSwan Website Resellers choose to operate their web design agency as a sole proprietorship because of the feasibility as well as all the other pros listed above.
2. Partnership
Do you have a friend or maybe a spouse that you’re considering going into business with? Partnerships are a popular business structure because they offer many benefits, including the sharing of management duties, financial resources, and profits. Plus, it’s not required to file paperwork with the state to establish a partnership. Typically, a legal document known as a written partnership agreement will be created to outline the responsibilities and level of ownership for each party. When it comes to filing taxes, each partner files respectively under their own name. Some examples of businesses that can be run as partnerships include: accounting groups, law firms, real estate investment firms, and physician groups.
Pros:
- Easy and inexpensive to set up: No extensive paperwork required, just an agreement from both parties that they want to go into business together.
- Profit share: Each partner shares in the profits and losses of the business, which can be an incentive to work hard and keep costs down.
- Collaborative effort: Partners can pool their resources and knowledge to create a more successful business. A partnership can provide continuity if one partner leaves the business.
- Flexibility in management and decision-making: More than one person can make decisions and the way that the business is run is determined collectively by the partners.
Cons:
- Equal liability: Each partner is jointly and severally liable for the debts and obligations of the partnership, meaning that each partner is individually responsible for the full amount of any debt or liability incurred by the partnership. This can be a big risk if one partner is not responsible with money.
- Group decisions: It can be difficult to make decisions as a group and partners may have differing opinions on how to run the business. Disagreements could lead to a break-up of the business.
3. Limited Liability (LLC)
A limited liability company (LLC) is another popular business entity option. Some of the most well-known brands including Nike, Mobile, eBay, IBM and Sony operate as an LLC. This type of business structure combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. This means that the owners are not personally liable for the debts and liabilities of the LLC. An LLC can be formed by one or more individuals, corporations, or other LLCs. If you are looking for a business legal structure that will give you limited personal liability, an LLC may be a good choice.
Pros:
- Personal liability protection: If something goes wrong with the business, your personal assets are safe.
- Save on taxes: Allows you to choose how you want to be taxed — as either a corporation or a partnership.
- Flexibility: Open policy in terms of management style and ownership structure.
Cons:
- Higher expense: LLCs can be more expensive to set up than other business structures.
- Required to pay certain taxes: Members of an LLC may have to pay self-employment taxes.
- Raising funds: Although LLCs are one of the best entities for business owners who want to raise capital, it can be hard to get funding from investors if you have an LLC and are still trying to kickstart your business.
- Increased regulations: Your business may be subject to more rules and requirements than other types of businesses.
4. Corporation
A corporation is a legal entity that is separate and distinct from its owners. Corporations can be either for-profit or nonprofit. Any big company you can think of is most likely a corporation. For example, Coca-cola Company, Apple, Google, Microsoft, J.P Morgan Chase, and Toyota all operate as corporations. The main advantage of incorporating is that it limits the liability of the owners. This means that if the corporation goes bankrupt, the owners will not be held personally liable for the debts of the corporation.
Under the corporation pillar there are two primary options, C Corporation and S Corporation.
C Corporation: C corporations offer several advantages, including limited liability protection and the ability to raise capital through the sale of stock. However, C corporations also have some disadvantages, such as double taxation of profits. When choosing a business legal structure, it's important to consider your company's size, ownership structure, and financial needs.
S Corporation: A S corporation is a business entity that’s separate from its owners, has shareholders, and pays taxes on its income. S corporations are advantageous because they offer limited liability protection to their shareholders. This means that if the company is sued, the shareholders will not be held personally liable for damages. S corporations also have the ability to pass income through to their shareholders, which can save on taxes. Finally, S corporations tend to be more attractive to investors than other business entities.
Pros:
- Limited liability protection for shareholders: This means that if the business is sued, the owners' personal assets are protected.
- A more professional image: The business is perceived to be well-established, credible and highly successful.
- Increased access to capital: Have an easier time raising money from investors. They can do this by selling stock in the company.
- Continuity: The ability to exist even if key personnel leave
Cons:
- Increased expense: Corporations can be more expensive and complicated to set up than other structures.
- Structured procedures and policies: Hold formal and regular meetings with stakeholders where you’ll need to keep detailed corporate minutes.
- Less flexibility: Adhering to certain processes and procedures that are expected.
- Pay more when taxes are due: Income taxes can be higher for a corporation than for other types of businesses.
Tips to Help You Choose Which Entity is Right for Your Business
Now that you are familiar with the different types of legal structures, you may have an idea of which entity you want to choose for your business. But, you want to feel comfortable and confident in your selection to help give you that peace of mind that you’re making the best choice. Before you make a final decision, consider taking these next steps:
- Do your research - Search online and read various articles that can help you further understand the benefits of choosing one legal structure over another.
- Compare your desired business to other similar businesses - Look at other startup businesses that are in your industry and see if you can identify the type of entity they operate as.
- Reach out to your network - Do you have a friend or family member that owns their own business? Reach out to them. Ask about their business entity they established. You may even consider reaching out to your extended network on social media to seek advice and ask questions to those who’ve been through the process of starting their own business.
- Speak to an accountant, lawyer or advisor - When talking to an attorney or financial advisor, keep in mind your business goals, the size of your company, and the amount of liability you're willing to take on. They can then help guide you and further explain your options to help you determine the structure that would work best in your situation.
In Conclusion…
Choosing which business entity you want to operate under is an important decision to make. The first step is to do your research. Understand your options and know the industry. You also need to identify your business goals and assets, and the liability you’re willing to risk.
Keep in mind that the legal structure you choose will have implications for how you operate your business, so it's important to choose carefully. The extra time you put into doing your research will be well worth it when you have your business structure solidified, setup and running. If you’re ready to take the next step, you can use a platform like LegalZoom to help you through the process of setting up your business entity and creating the legal documentation you may need for your new business venture.
As you can see, starting a business and choosing a legal structure can actually be quite easy. If you’re interested in starting your own business but are still shuffling through your options, consider launching a web design business with SiteSwan. There’s no technical experience required, and you’ll get all the resources and tools you need to run your business so you can start building and selling websites in no time. Get started today!
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