Selecting a business entity
Selecting a business entity for your business is a big thing and shouldn’t be done lightly. Below, you will find a few examples of things that are smart to take into consideration when choosing which type of entity that is best for your business.
How much legal liability are you willing to take on?
With a C corporation or S corporation, there is a high degree of separation between the owner(s) and the business entity. Essentially, it means that you won’t have to take money out of your private account to pay for liabilities pertaining to the business entity (as long as you have followed the law, of course).
With a sole proprietorship or partnership, you are legally responsible for liabilities pertaining to the business. Also, with the partnership, you are – to a great extent – legally responsible even for decisions made by any of your partners on behalf of the business.
The Limited Liability Company (LLC) is a business structure that is less difficult to set up and maintain than the corporations, but still offers a high degree of liability protection for the owner(s). It can be a great middle-road compromise for a small business where the owner(s) wants to safeguard their private assets.
How to manage income, costs, profits and losses from a tax perspective vary a lot depending on which business entity you have. With a sole proprietorship or partnership, all this can be pass through onto the individual owners. With a standard corporation, that is not possible – everything is settled within the corporation.
The so-called “double taxation” is an issue that makes some business owners shy away from forming a corporation. In some states, you can form an S Corporation (instead of the standard C corporation) to stay clear of the double taxation problem, provided that the corporation doesn’t have dozens of shareholders.
One of the reasons why an S corporation can be more appealing than a C corporation is the ability to let business losses reduce personal tax liability for the owner(s) – something that can be especially important during the start-up years of a business.
Cost of formation
Obsessing with keeping the cost of formation as low as possible is dangerous, because choosing a sup-optimal business entity can cost you much more in the long run. Naturally, the cost of formation should be taken into account, but it should preferably not be the only deciding factor.
Cost of ongoing administration
Unlike the cost for formation, the cost of administration is a cost that you will continue to have – and it can certainly add up over time. What will it cost you – in time, money and energy – to do the record-keeping and filing required for a specific business entity? For some small business owners, starting a C corporation is simply not the best choice because of the associated administrative requirements. It might be cheaper to pay for a comprehensive umbrella insurance policy as protection from some of the financial liability associated with the sole proprietorship or partnership.
- What are your hopes and dreams for your business, and will this business entity be suitable for them?
- In your jurisdiction, how complicated would it be to change from one type of business entity to another one if you need to in the future, e.g. going from sole proprietorship to corporation?
- Do you want the business to go on existing even if you can no longer work in it, and what kind of business entity would that require?
- Do you want to be able to sell the business or take in outside investor/co-owners?