You decided to start your own small business and probably realized early on that it’s no easy task. Except determination, knowledge in your field and a relative experience, you need all sorts of business-y knowledge. Managing a business, no matter if you’re solo or partnered, requires a lot of hard work and dedication.
But in order for your small business to thrive, you must choose the right business structure that best reflects your internal operations and future aspirations. The majority of freelancers and business owners don’t have a management background and find it hard to navigate through all this. This is where we come in!
Different types of a small business structure
In a previous post, we discussed the benefits of incorporating your one-man shop; changing its legal entity that is, in order to enjoy tax benefits and grow in general. In this one, we are going to help you discover what are the different types of businesses and help you decide which business structure type is right for you, explain your options and mention some points that require caution on your behalf, before deciding.
The Partnership business structure
What is it?
A partnership is a business that has two or more owners and each of them holds a percentage of ownership. That percentage can be evenly divided or reflect the contribution each partner has given to the business in terms of funds, labor, property and so on. So, it could be 50-50 or 70-30, depending on the situation. It’s a fairly simple business structure in which partners share both profits and liability, to the extent of each one’s ownership percentage, of course. There are three types of partnerships; General partnerships, limited partnerships, and joint ventures. In order to choose wisely, let us elaborate here each business structure.
- General partnership: Μeans that all members involved are equally liable, share profits and responsibilities.
- Limited partnership: This complex business structure is usually preferred by partners that want to invest in a company but have limited say in running it.
- Joint venture: Essentially a general partnership with an expiration date. If you decide you need a partner to take on a specific project, the joint venture is for you.
Α partnership is the upgraded version of a sole proprietorship; It’s easy to establish, has small registration fees and you get to share the risk with someone you trust. Another benefit of choosing the partnership as a small business structure is that you also get to share the losses in case something goes wrong.
Choosing this type of small business structure does not protect your personal assets or your partners’. You both have “skin” on the line in this case but share liability. Furthermore, your business earnings are directly taxable just as in the case of a sole proprietorship. It is also important to draft a partnership agreement outlining each partner’s role and the procedures followed, in case one of you decides on taking a different direction professionally.
The LLC (Limited Liability Company)
What is it
The LLC is the ideal mix of sole proprietorship’s flexibility coupled with the limit in personal liability of its members, which is important to every new entrepreneur desires. Forming an LLC protects the owners from the business/rental operations. The members of the LLC can enjoy this protection provided that they act responsibly and within their duties’ scope. So, if you have certain personal assets you wish to protect and this deters you from starting a business, starting an LLC instead, might be the perfect solution for you.
Benefits of forming an LLC
You get taxed on your share of profits only and contribute to losses as far as your share goes. Moreover, you can form an LLC of one in the majority of states, enjoying the full capacity of a one-man shop while having the liability protection found in corporations. Finally, LLCs require a lot less record keeping than corporations.
Drawbacks of having an LLC
The LLC is significantly difficult to form since you’ll have to choose a business name that ends with the abbreviation of “LLC”, create an operating agreement and file your articles of organization. Conversely, each member of the LLC needs to file additional papers regarding state and federal taxes which depends on the number of the LLC’s members. Keep also in mind that the LLC’s members are taxed for their payroll, as well, so you don’t save on taxes by choosing this business structure. Finally, depending on the state, there are certain registration fees that need to be factored in the LLC’s expenses.
What is it
As discussed in our previous article, this business structure is highly complex, thus suitable for large companies, with many employees and shareholders. Each state has different rules on registering a corporation, so you need to do your research before deciding. This business structure is considered to be the LLC’s upgraded version, for when business is going well and the team is inevitably growing. Along with the team, grows also the risk, and this is where the corporation steps in to save the day!
Registering a corporation means acquiring a tax ID number, paying local, state and federal taxes filed by every shareholder separately. Corporations, according to their industry, abide by certain rules and regulations, so you pretty much get how setting them up can be complicated and costly.
Benefits of forming a Corporation
The corporation is an entirely separate legal entity from its shareholders, which means that individual property and assets are off limits, should things go south for whatever reason. Moreover, corporations are quite flexible in cases of transferring your shares to other shareholders or raise corporate capital. They are also more attractive to employees as they can be compensated in shares, partly. In some states, corporations may pay lower taxes than individuals which automatically gives them a competitive advantage over LLCs and partnerships.
Drawbacks of owning a Corporation
In some states though, shareholders of small corporations may be required to pay taxes twice. There will be taxes applied to the corporation’s profits, and then the shareholders are required to pay taxes in their shares of profits, as a form of personal income. Additionally, as we mentioned above, setting up a corporation is a bit more difficult than other business structures. Another thing you need to bear in mind is that corporations require extremely neat record maintenance. If not, shareholders may lose the limited liability it offers, as acting as a separate legal entity cannot be proven.
The “S” Corporation
If your corporation is located in those US states where the double taxation problem is unavoidable, the “S” corporation is ideal for you. You get to protect your personal assets and pay taxes just once. Most small business owners should, at least once, entertain the idea of moving their business structure to an “S” corporation. Overall, the benefits and disadvantages of such a move are the same as the simple corporation’s.
So, which business structure is right for you?
In reality, there is no “one size fits all” formula here; everything depends on your business’s industry, its profits, and size. Μost freelancers choose to go with the LLC or partner up with someone down the line. In any case, it would be wise to get solid advice from an experienced tax consultant before spending a dollar on registration fees to upgrade your business’s current structure.