Once you’ve gone through the first few steps to starting your business, the next thing you’ll want to do is choose a business structure to operate under and make it all official.
This is one of the most important decisions you’ll make during the life of your business because it has so many effects on how you run it.
From how much personal liability you’ll have if something goes wrong in your business to how much your profit will be taxed — you need to protect yourself.
If you choose the wrong structure for your business you could not only end up paying more of your hard earn money away in taxes but put yourself and assets (house, car, etc) at risk.
Let’s get this right the first time, shall we?
Quick Note: If you get lost at any point in this guide, check out IncFile’s simple checklist for deciding on the proper entity for your business.
Quick Note: If you get lost at any point in this guide, check out IncFile’s simple checklist for deciding on the proper entity for your business.
With those key factors in mind, let’s talk about each of the options you have and decide which business structure is the right one for you. Let’s dig in!
As long as you don’t have any partners, are providing a product or service to customers, and have not set up any other legal entity for your business — then you are automatically a Sole Proprietor.
A Sole Proprietorship is the simplest business structure. In fact you don’t have to do anything but set it up. There is nothing to file or any reason to get an expensive lawyer. But there are a couple things you will need to do to be compliant, which we’ll get into below.
Other than that, all you need to do is disclose all your business’ information for your taxes when it comes to your income.
There is actually no difference between your business and personal liability as a Sole Proprietor. You are personally liable for debt, mistakes, or anything else along those lines that are acquired by your business.
The liability will vary depending on the kind of business you are planning on opening. And it could even be something you don’t have to worry about.
For instance, if you sell digital ebooks on the history of your country, you should be in the clear from liabilities.
However, if you are starting a business that transports large rocks from location to location through populated areas or roads — you might want to rethink being a Sole Proprietorship.
As a Sole Proprietor you pay taxes on all earnings for your business.
You pay a similar income tax rate on money from your so proprietorship as you pay if the money came from an employer.
You generally will not be able to raise money from investors or banks as a Sole Proprietorship. There will always be an exception, of course, but don’t expect it to be you. For financing your business you’ll probably want to incorporate.
Businesses of one.
Freelancers, plumbers, consultants and even attorneys can be Sole Proprietors.
Keep in mind though, there are still things that you will need to be compliant as a Sole Proprietor. If you don’t make sure they are taken care of, you could be in serious trouble.
If you are wanting to do business under a different name from your own, you will need to register a ‘Doing Business As’ or a ‘DBA’. So instead of operating as Steve Johnson you can ‘do business as’ SJ Consulting.
This way, when you receive checks or get paid for the service (or product) you offer, everything would be made out to SJ Consulting rather than just, Steve Johnson.
If you’d like to get a DBA, you can zoom through the process (while having it done correctly) through LegalZoom or Rocket Lawyer. All you have to do is answer questions about your business in a Q&A or multiple choice format and they take care of the rest.
Your city or county will require if you are in business or engaging in business you get a business licenses in our case. You will need to check with both of those websites for your state to figure out which licenses you’ll need.
Make sure to double check that you have the right ones, making a mistake here can be costly. Especially as a Sole Proprietor with all of your personal assets on the line.
To make the process of getting all the licenses you’ll need to run your business within the law, you can get all of them all in one place with Business Licenses.
As long as your business has a very small chance of liability, operating as a Sole Proprietorship might be right for you. Just make sure you are able to keep track of your tax information for when the time comes.
General partnerships are similar to Sole Proprietorships in a sense that it is a very basic business structure. Like a Sole Proprietorship, there are no documents or anything you’ll need to file to operate as a General partnership.
If two or more partners agree to do business with each other and do not set up another type of business structure then they are automatically a General Partnership with no official paperwork required.
Let’s say you and a friend start working on a business together. You should have a strong and clear agreement between the two of you (highly recommended) that outlines who owns what percentage of the business. In addition to that, what happens if one of you decide to leave the business, what activities each of you will carry out, and more things along those lines.
What’s cool about Rocket Lawyer’s Operating Agreement is that it’s fully customizable and allows you to cover all of those important bases for protection.
Another thing to keep in mind is that you will typically not be able to raise money from investors as a General Partnership. It does happen, but is pretty uncommon.
(Like a Sole Proprietorship, you might want to file a DBA)
Like a Sole Proprietorship, there is no difference from a liability standpoint. That being said, it is very important to keep in mind that you are liable not only for yourself but also for your partner as a General Partnership.
For example, if your partner goes out and beats somebody up on the job and then your business gets sued; then you’re personally liable right along with him (or her).
Other than getting insurance if someone is suing the business, they are suing you personally and that is why people want to often get a corporate entity (LLC, C Corporation, S Corporation) so there is some level of protection for your assets.
Like Sole Proprietorships, General Partnerships are taxed only at a personal level and all income from the General Partnership is subject to taxation regardless of whatever is left in the business are paid out to the partners.
You will pay a similar tax rate to what you would have the money come from an employer.
Because of the additional liability and the potential disputes that come up with General Partnership, we don’t recommend operating as one. But if you decide that it is right for you, make sure you get all of the appropriate state and local requirements taken care of.
If you do not have the funds currently to set up as the other business structures below then at a minimum, make sure you set up a strong partnership agreement that can be reviewed by a professional.
If you’re wanting to work with a partner and still get the protection, check out the next options for your business’ legal structure.
LLC’s (Limited Liability Company) are the most common entity for business owners and the first structure you should consider when incorporating your business.
An LLC separates you (and your partners) and your company from a business and liability perspective. It also provides a lot of flexibility on how your business will be taxed and run.
For an example, if somebody tries to sue you, they are not suing you personally but suing the LLC. What exactly does this mean?
It means that they can only get as much as the assets you have in your business. But no more. Your cash, house, property and other personal assets you own will be protected.
The LLC is easy to use, easy to set up, very flexible, and very straightforward.
You can incorporate your LLC by going through your state and local authorities or through an online incorporation service like IncFile (for $49) or LegalZoom (for $149). IncFile is the most popular option.
What’s great about an LLC is that most states allow what is known as a ‘single member LLC’ so you generally don’t have to have a partner in order to set up a LLC. This means you’ll get significantly more protection than you would as a solopreneur Sole Proprietorship.
Like we said before, as an LLC, if anything were to go wrong your personal assets would be protected as long as they are not tied to your business.
If you have partners, you should be absolutely sure that there is a solid and clear Partnership Agreement that outlines who has what responsibilities, how the business will be run, and how issues that may arise will be handled.
We understand that you might be partnering with someone you trust with your life, but having that contract could end up saving your relationship and business if something were to go wrong.
Your LLC will give you the protection of a corporate veil and for tax purposes.
It is straightforward because it is a pass-through tax entity which means you’re only getting taxed on the amount of money that you personally take out from the LLC (your personal income).
However, LLC can also elect to be treated as a C Corporation or S Corporation from tax standpoint. Keep in mind that your LLC should not be run with your own personal affairs.
For instance, if you don’t have a separate business or checking account for your business, then in a lawsuit situation the point could be made that since your finances aren’t separate and the LLC protection of your personal assets shouldn’t apply.
Scary, yes. Preventable, absolutely.
What’s cool about the LLC is that it gives you liability protection and the option to choose how you would like to be treated when it’s time to pay taxes.
They also require less paperwork and maintenance than a C Corporation (below) for these reasons they should generally be the first option considered when seeking a legal entity that provides liability protection.
The biggest advantage to a C Corporation over an LLC is the ability to raise money by taking the company public.
But if you’re not planning on raising outside money like this, the LLC may be a better option because it offers the liability protection and much more flexibility from a tax perspective.
Like the LLC, a C Corporation treats the individual business owners and the business separately from a liability standpoint. So you’ll still be getting that ‘corporate veil’ that will protect your personal assets.
If you follow Peter Thiel’s motto of giving stock options to employees then you will want to be registered as a C Corporation.
Note on venture capital:
It’s important to keep in mind that most venture capitalists prefer investing in companies that are operating as C Corporations. This is the case because C Corporation are much more flexible from an ownership perspective.
Your tax, as a C Corporation, will require more paperwork than it would as an LLC. So if you plan to take your company public eventually then you will most want to be operating as a C Corporation.
Here are a few additional things to keep in mind:
Like an LLC, you are required to file paperwork to set up your C Corporation. The initial cost for setting up a C Corporation is similar to that of an LLC.
You’ll have to go through your local authorities to register your business and make it legal. If you’d like to simplify the filing process though, you can use an online incorporation service like IncFile (for $49) or LegalZoom (for $149) to make sure everything is taken care of. No need to think, “Oh crap, did I file that?“.
Let’s assume later on that one of your partners want to leave the business. Since C Corporations are seen as separate entities from you and your partners, it can continue to operate with no harm or hassle done.
Just make sure that you have a well crafted Partnership Agreement that outlines terms if there were ever any disagreement between any of the partners and what would be done if somebody wants out.
Again, not having a written agreement could bring on some serious problems in the future. So make sure you do it!
They have shareholders, and they have Board of Directors. Let’s talk about the basic breakdown of how this works.
Your board of directors will likely decide who runs the company at the end of the day. So the more of an investment you take on, the more control you’re giving up.
And if the board doesn’t like you where you are in the company, they can replace you without a second thought. (As long as they have majority ownership of the overall business). Think of Steve Jobs getting kicked out of Apple back in 1985.
Unless you’re planning to raise a large amount of money from venture capitalists or take your business public, an LLC will give you many of the same benefits with more flexibility.
You also have the option to start as a LLC and switch to a C Corporation when you are ready to take on an investor or board.
It will be more expensive and have more legal fees in the long run, but if you prefer to start as an LLC and switch to a C Corporation, that isn’t completely uncommon.
An S Corporation is a bit of a mix between a C Corporation and a LLC. It’s basically a pass-through tax entity.
In other words, they can elect to have their business treated as an S corporation from an IRS standpoint. This allows C Corporations to avoid the double taxation issues. (Because who wants to get taxed twice?)
Before the LLC was created, S Corporations were used so that business owners would not get double taxed. But nowadays most people choose to operate as an LLC because of its simplicity and flexibility.
The S Corporation is simply a designation with the IRS for tax purposes so that liability is the same as it is underline LLC or C Corporation that are elected to be treated as a S Corporation.
But you will need to keep in mind that your business will have to be a domestic operation, have only allowable shareholders, and may not include partnership to qualify your LLC or your C Corporation is elect to be treated as an S Corporation.
Also, your S Corporation cannot have more than 100 shareholders and it can only have one class of stock. To be treated as an S Corporation you must set up your LLC or your C Corporation on a first and then file a form 2553 with the IRS to become an S Corporation.
Is an S Corporation right for you?
If you’re operating as an LLC already then there is no reason to choose to be treated as an S Corporation until the business is producing enough profit to pay yourself a substantial salary.
Although we built this guide to make the process of deciding which business structure you should choose for your business, it is up to you to determine the best entity for your business.
At the end of the day, it’s always a good idea to talk to a professional about the business entity you should choose. But at the same time we understand that hiring an attorney to sit down with you may not be as affordable at this stage in your business.
So if you’d like a resource to help determine the business entity that might suite your business best, ask a qualified attorney in your area.
Without doing so, it could shut down everything you’ve been working for because ‘technically’ you’d be operating illegally.
All you have to do is visit your state and local websites to figure out which ones you will need. Depending on your area and industry, you’ll likely need to meet different requirements than the next gal or guy.
If you need help or find contacting the local authorities a little tedious, Business Licenses will find all the documents you’ll need for you. They just ask questions about your business and location. After that they’ll either send you the documents to fill out and sign or fill them out for you and send them to you for signing. (It depends on which package you choose.)
(Note: We are not practicing attorneys, just entrepreneurs like you. That being said, we recommend you get this advice from an attorney in more detail or before you go to actually incorporate your business. This guide is meant for general information and in no way constitutes legal advice.)