Businesses generate income and play an essential role in promoting economic development. They are also responsible for navigating social and economic institutions. They need to be strategic and systematic and have the right expertise and financial knowledge.
Picking the correct business structure has a significant impact on liability, taxes, and management. It’s important to consider legal complexities, scalability, and industry rules. Legal professionals can help evaluate the risks and benefits of different options.
Sole proprietorship
As the name implies, a sole proprietorship is a business owned and operated by one person. It’s easy to start and requires no formal paperwork at the federal, state, or local level. However, this type of business does have certain disadvantages. For example, it’s challenging to secure financing from banks because the company lacks a track record. Also, creditors don’t have protections against seizing the owner’s assets, which could be an issue if the company defaults on its loans.
In addition, a sole proprietorship can be taxed at the individual owner’s income tax rate rather than the corporate rate, which is a plus. This makes it more attractive to some entrepreneurs. Likewise, you’ll be able to write off business-related expenses, such as advertising and operating costs, on your tax return. You may also be able to claim tax deductions for meals and entertainment if they are related to the business.
Although it’s an advantage to be able to deduct business expenses, this can also increase your tax liability. This is why many people choose to form a limited liability company (LLC) instead of a sole proprietorship. This allows them to keep their personal and business expenses separate, avoiding double taxation. Additionally, they can take advantage of the tax benefits provided by the LLC, such as lower individual tax rates and fewer reporting obligations.
Another disadvantage of a sole proprietorship is that it’s difficult to sell or hand down the business if the owner decides to quit. This is because the company is linked to the owner by nature and not a separate legal entity. If you want to sell a sole proprietorship, you’ll need to register it as a DBA or “doing business as” name and transfer the usage rights to someone else.
If you’re thinking of starting a business, consider the long-term goals of your company before choosing a structure. While a sole proprietorship might be a good choice for your startup, you might need to change the structure of your company as it grows or takes on employees. Changing the structure of your business can be expensive, but it might be worth it if you have a long-term plan to grow your company.
Partnership
Unlike a sole proprietorship, a partnership is an association between two or more people who agree to work together. The business partners divide up the responsibilities of running the company and share profits and losses. They can decide how the business will be managed and can set out terms in a formal agreement, which can be written or oral. The disadvantage of a partnership is that the partners are personally liable for any debts or losses the company incurs, which can affect their financial security. Moreover, the lack of legal personality makes it difficult for the business to acquire property or enter into contracts in its name. This can make it harder for the partners to sell their shares in the company.
A partnership can be a great way to grow your business. In addition to bringing additional resources, you can also leverage the expertise of other partners to improve the quality and scope of your services. However, it is essential to understand the risks and drawbacks of a partnership before you embark on one. A well-drafted partnership agreement can minimize potential problems, such as conflicts of interest or disagreements about how to manage the business.
Another advantage of a partnership is that it provides flexibility and tax benefits. Unlike other forms of business, partnerships do not pay taxes as their entity. Instead, the company’s revenue passes through to its partners, who must report and pay taxes on their share of the business. This eliminates the need for a separate corporate tax return and can reduce administrative costs.
In contrast to the requirements of other business structures, a partnership has few government requirements. Depending on the industry, you may need to register your business name with local authorities or file a fictitious name (also known as an assumed or DBA name) to operate under a different name. You should also obtain any necessary licenses or permits, which vary by state and industry. You can use the SBA’s Licensing & Permits tool to find out about federal, state, and local regulations in your area.
Corporation
Corporations are a popular option for businesses that require significant capital and may want to expand nationally or internationally. This business structure is recognized as a separate legal entity and offers robust protection for its owners. The personal assets of shareholders are protected against lawsuits and other financial obligations. In addition, corporations can raise funds by selling shares to the public. However, corporations can be complex and costly to establish, and they have strict regulations and requirements that must be followed. It is essential to seek the advice of an attorney and tax advisor before choosing this type of business structure.
The term company is sometimes used to refer to a corporation, but the word corporation is more commonly used in the United States. This business structure has the benefits of a sole proprietorship or partnership, but it is more formal and offers less personal liability. It requires more paperwork and has more stringent legal requirements, including maintaining bylaws, creating annual reports, holding meetings, and keeping meeting minutes. It also requires a higher initial investment than other types of business structures.
The process of incorporating a business varies from state to state, but there are some general steps to follow. First, choose a name for your corporation that complies with your state’s rules. It should include designated words such as “Limited,” “Incorporated,” or “Corporation.” You can check the website of your state’s business formation agency for a list of restricted terms. You can also reserve a name for a limited amount of time before filing. Then, draft articles of incorporation and file them with your secretary of state. This process can take weeks or months, but it is crucial to comply with all the legal requirements.
Limited liability company (LLC)
The limited liability company (LLC) is a famous structure for small businesses. It has several advantages over other business entities, including limited personal liability and pass-through taxation. In addition, it is easier to form than a corporation. However, there are certain drawbacks to LLCs that should be considered before deciding to incorporate your business. These include legal liability, tax implications, operational costs and fees, and your financing needs.
To form an LLC, the owners draft an operating agreement and file articles of organization with the state. While the process is similar to creating a corporation, it is typically less cumbersome than the corporate filings required by a public corporation. The articles of organization request basic information about the new entity, including the name, location, and management type. Most states also require the designation of a registered agent. While people within the LLC can serve this role, many states maintain lists of third-party companies that perform this service.
Once the articles of organization are filed, the state will issue a certificate or other proof of formation. This will serve as legal proof of the LLC’s existence and is often needed to open a bank account, obtain an EIN, and register in other states. Some states may also require that the LLC publish notice of its formation in two newspapers. This is an excellent way to keep the public informed of any changes in ownership or other important events and is generally a requirement when registering in multiple states.
Most financial institutions require that a federal Employer Identification Number (EIN) be obtained before opening a business bank account. The EIN serves as a unique identifier for the LLC and can be used on all income and employment tax filings. It is also important to note that checks written to an LLC cannot be cashed and must be deposited into a business bank account.
In addition to maintaining detailed records, it is crucial to separate business finances from personal ones. This will help prevent courts from piercing the veil and holding an owner personally liable for the business’s debts. A business credit card can be helpful in keeping personal and business transactions separate and establishing business credit.
