Starting small business calls for important decisions to be made right from the beginning. You need to make decisions concerning; staffing, business location, target market, financing, operating hours, and much more. But even before you make these decisions, the most important decision to be made is the one concerning the choice of business structure.
Your choice of business structure will not only determine the amount of taxes you will pay but also the load of paperwork your entity will have to deal with, personal liability and the capital requirements.
Types of Business Structure
Types of the business structure include; sole proprietorship, partnership, corporation, S corporation, and Limited liability company.
In a sole proprietorship, the entity is owned by one person who is personally liable for the financial obligations of the business. There exists no distinction between the owner and the business. The owner also incurs all the losses. However, such entities are easy to form, and the owner has complete control of it. Additionally, the owner only pays taxes on profits, not corporation tax.
In partnerships, two or more people share the losses and profits of the business. They are easy to form because there’s no registration with the state or even the payment of start-up fees. In this structure, the filing of taxes is way easy because the business isn’t taxed, just the partners. On the weak side of this structure, all the partners are personally liable for the liabilities of the firm.
Corporations, on the other hand, are businesses owned by a group of people called shareholders. A corporation is an artificial person, and hence there’s legal separation between the firm and the owners. It’s the corporation that pays taxes, not the owners. It’s the corporation that incurs liability, not the owners. However, this type of business is associated with a lot of paperwork as well as high taxation.
An S corporation is a form of corporation in that the owners have limited liability. However, S corporations don’t pay income tax. Instead, losses and profits are passed over to shareholders. They are expensive to set up.
Limited Liability Company
A limited liability company (LLC) is a hybrid of a corporation and partnership. It has gained popularity to owing to the fact that profits and losses can be passed over to the owners without the business getting taxed and also the owners have limited liability. However, it is difficult to raise start-up money because lenders and creditors still find corporations to be more attractive.
Choosing the Right Structure
So, what are the factors to consider before you pick the right structure for your business?
1. Legal liability
A good business structure will ensure insulation of the owner from legal liability to a greater extent. Under this consideration, you need to ask yourself how much your business exposes itself to liability and question your ability to afford the risk brought forth by the liability.
2. Tax considerations
There is a good chance that you aren’t well-versed with the tax implications associated with various business structures. To avoid flying blind, you should consult a tax attorney near you.
You need to pick a business structure that has opportunities to minimize taxation. Note that double taxation is mostly associated with incorporation. However, S corporations have a way of maneuvering double taxation. You can’t also ignore the fact that corporations have more tax options than partnerships and sole proprietorships.
In picking a business structure, you need one which will be flexible enough to meet the needs of the firm as well take into consideration the personal needs of its owners.
4. Start-up cost and administration needs
Sole proprietorships and partnerships are very popular because of their low start-up costs and reduced management demands compared to incorporated entities. Incorporation in itself isn’t cheap, and it attracts a large cost of record-keeping and paperwork.
In as much you’d like to benefit from limited liability as well as tax advantages but can you pay for the start-up cost of incorporation as well as handle the administration demands?
5. Future needs
In starting a business, we are more often than not caught up in getting the business on its feet that we forget to speculate what will happen to it 3, 4, 5 or even 10 years down the line. Yes, you are starting a business, but I’m sure you don’t want to wind up after 6 months. You want an entity with an unforeseen future.
You need to ask yourself questions like; “What will happen to the business after I die?”, “What if I decide to sell my share in the partnership?”
As you pick a business structure, have eyes on the future and its dynamicity.
Selecting a business structure is not a light decision. You need to consider all of the above factors. Additionally, you may wish to seek the expert advice of a tax attorney to help you make the right decisions. You can also talk to owners of existing businesses for guidance.