As a business owner, you have a lot on your plate when establishing a new business—from looking for funding for your startup to product creation and then business marketing. That said, there’s one process that you shouldn’t overlook: choosing a business entity.
Deciding on the right entity as you form your startup is essential and can have several implications on your business, taxes, personal finances, long-term plans, and success. This article can serve as guide for first-time business owners like you when it comes to selecting the right business entity for your startup.
Assess Your Needs
Every startup has specific needs. You should take a closer look at your startup’s operation and situation to fully understand what you need and want to achieve. Examples of these needs include:
- Personal asset protection
- Company control
- Operating costs
The right entity for your startup is the one that can meet these needs, among many things. This helps you narrow down your options and find the most suitable one for your current objectives.
Understand Your Options
Once you have a list of your business needs, the next thing you need to do is to understand your options. In general, there are four major types of business entities.
- Limited Liability Company
If you’re looking to take your startup to the next level, then forming a limited liability company (LLC) is a great choice. It’s relatively easy to form one on your own or you can hire the best LLC formation service. This entity also has no limits on the shareholders you can have, which is critical if you want to pursue investors.
The biggest benefit of forming an LLC is liability protection; it separates your personal asset from the company asset. Apart from this, it allows profit to pass through to shareholders as income on personal tax, preventing double taxation.
- Sole Proprietorship
Technically, if you have a business, it’s automatically considered a sole proprietorship. This means setting it up is simple and inexpensive. You don’t need to file paperwork since you exist and are already considered an entity when you register your business.
That said, being a sole trader comes with numerous cons, including the fact that there’s no legal separation between your personal and business assets and the reluctance of banks to lend you money for funding.
A partnership is a great option if you’re starting your business with a friend or a family member. This type of entity is further classified into a limited partnership, where only one partner has full operational control and the other only contributes and receives a part of the profit, and a general partnership, where all partners have equal operational control, investment, and share of profits.
A partnership is easy to form and offers better growth potential than sole proprietorships. You’ll still need a lawyer to help create and review your partnership agreement as well as form the entity.
This is a more formal type of business entity. It can be categorized into three: c-corporations, b-corporations, and s-corporations.
A corporation is characterized by a more complicated legal structure, intricate tax requirements, and numerous shareholders. Thus, they’re more suitable for larger businesses. This type of business entity offers the most limited liability and more potential to increase capital. Obviously, corporations are quite complicated to set up and may incur double taxation.
3 Important Factors To Consider When Choosing A Business Entity
There are several things you need to consider when determining which business entity to choose. You should start with these three:
1. Legal Protection
If your startup carries significant liability, then separating your personal assets from your business is critical. In general, LLCs and corporations offer the most liability protection, with the former being more suitable for startups.
If not controlled, taxes can take a huge bite on your profits. One way to control taxes is through the formation of the right business entity. C-corps have double taxation, meaning that both the company and shareholder profits are taxed. Meanwhile, LLCs, sole proprietorships, partnerships, and s-corps are considered pass-through entities, meaning that profits are taxed and paid out to the owners, saving more money.
3. Number and Types of Owners
If you’re not thinking of making your startup public, you’ll need to choose an entity based on the number of owners. A sole trader can only have one owner, but partnerships, LLCs, and other types of corporations, except c-corps, can have multiple owners.
Choosing the right business entity from the beginning is essential for your startup’s operation and longevity. Understanding your options and choosing the most suitable business structure can help you better protect your startup in the long run. More importantly, it can contribute to its growth. Given the significance of this decision, you’re advised to take all the time you need to consider all the important factors before actually selecting.