Whether you are starting a new business, or have one that is already established, you need the right legal structure. This is one of the most important decisions you will have to make because it will impact your personal liability, and your ability to raise capital. In addition, it will determine how much you will need to pay in taxes.
If you have been trying to find out how to choose a business legal structure for your startup, or how to change the legal structure of your existing business, continue reading this Balboa Capital blog post. It explains the key characteristics of each type of business entity. Just remember that every company’s situation is unique, so it is a good idea to consult with a business attorney prior to making your decision.
This is the most popular business structure in the United States. According to the Small Business Administration website, more than 70% of businesses in the US are operated by sole proprietors. This type of business entity is easy to set up and you will not have to hold annual meetings or record meeting minutes.
As a sole proprietor, you can use your company’s profits however you want, and you are responsible for all debts, losses and liabilities. Potential drawbacks of this structure include increased liability in the event that you receive a lawsuit or start piling up debt. You might also find it difficult to secure a loan or business line or credit from your bank or credit union.
Limited Liability Company (LLC).
This business entity provides the limited liability of a corporation and the single taxation benefits of a sole proprietorship or partnership. If your LLC has one or more partners and/or shareholders, your company’s profits will be distributed in a manner that everyone agrees with. Your LLC can have an unlimited number of owners, and each owner can report business profit and loss on their personal tax returns.
To form an LLC, you will need to file Articles of Organization with your Secretary of State. Some States require LLC’s to have operating agreements, which are legal forms that provide a complete overview of the company’s ownership and operating procedures. Ask your business attorney if you will need one.
This is one of the most complex business structures. To become an S corporation, your company needs to fall under the eligible list of corporations and be based in the United States. An S corporation can have only one class of stock, and no more than 100 shareholders. In addition to limited liability protection, S corporations present you with some attractive tax advantages.
You will not be taxed on both your corporate income and dividend income. Instead, your income and losses will be reported on your personal tax return. The same applies for any co-owners or shareholders that your company has. In most cases, S corporations are exempt from having to pay state corporate income tax.
There are some notable differences between a C corporation and an S corporation. The profits of a C corporation are taxed when earned, and taxed a second time when distributed as dividends. In addition, the shareholders in a C corporation are not able to deduct any corporate losses.
Unlike an S corporation, a C corporation is not limited to a specific number of shareholders. Similar to S corporations, C corporations offer limited liability protection.
Changing your business structure.
When you first launched your small business, you probably picked a legal structure that was best for you at the time. If your company has experienced growth since its inception, it might be time to look at a structure that offers greater legal protection and bigger borrowing power. For example, if you started out as a sole proprietorship a few years ago and have increased the number of employees on your payroll, a corporation or an LLC offers more liability protection.
These structures also help protect your personal assets from customer injuries and visitor injuries. When it comes time to apply for business funding, a formal business structure such as a corporation or an LLC can improve your chances of having your application approved. If you decide to change your company’s legal structure, hire a business attorney so every step of the process is done properly. The cost of hiring an attorney far outweigh the costs associated with unexpected issues down the road.
As mentioned earlier, we recommend that you contact your business lawyer or accountant for more information about business legal structures. These professionals are well versed in legal structures, and they can provide you with the best advice and help guide you in the right direction.