How to Choose a Business Legal Structure

how to choose a business legal structure

Estimated reading time: 4 minutes

Whether you are starting a new business or have already established one, you need the right legal structure. This is one of the most important decisions you will have to make because it will impact your 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. Remember that every business owner’s situation is unique, so it is a good idea to consult with a business attorney before making your decision.

Sole Proprietorship.

This is the most popular business legal 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 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 business’s profits however you want, and you are responsible for all debts, losses, and liabilities. Potential drawbacks of this structure include increased liability if you receive a lawsuit or start piling up debt. You might also find securing a small business loan, business line of credit, or another type of small business funding challenging.

Limited Liability Company (LLC).

This business legal structure provides the limited liability of a corporation and the single taxation benefits of a sole proprietorship or partnership. In addition, if your LLC has one or more partners or shareholders, your business’s profits will be distributed so that everyone agrees. As a result, 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 must file Articles of Organization with your Secretary of State. In addition, some states require LLCs to have operating agreements, which are legal forms that provide a complete overview of the business’s ownership and operating procedures. Ask your business attorney if you will need one.

S Corporation.

This is one of the most complex business legal structures. To become an S corporation, your business 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 offer 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 to any co-owners or shareholders that your business has. In most cases, S corporations are exempt from paying state corporate income tax.

C Corporation.

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 cannot 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.

When you first launched your small business, you probably picked a legal structure that was best for you at the time or perhaps filed a DBA. However, if your company has experienced growth since its inception, it might be time to look at a structure offering more significant legal protection and considerable borrowing power. For example, a corporation or an LLC provides more liability protection if you started as a sole proprietorship a few years ago and have increased the number of employees on your payroll.

These legal structures also help protect your assets from customer 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 correctly. Hiring an attorney far outweighs the costs associated with unexpected issues down the road.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.