How should I legally structure my business?I get this question almost every time when coaching a start-up. Needless to say, it is an important question and one which requires some thought about how you want to manage your new business.
There are a number of business structures each with pros and cons and centering, mainly, around the issue of liability with the secondary considerations regarding financial and tax reporting. The types of business structures and their definitions are:
- Sole Proprietorship
- General Partnership
- Limited Partnership
- Limited Liability Partnership
- Limited Liability Company (LLC)
- Sub-chapter S Corporation
- C Corporation
- A Sole Proprietorship consists of one individual or married couple. The most simple to form, the SP is the most common form of business structure. It is easy to manage and not burdened with legal controls or tax requirements and reporting.
Their principal problem is that the owners are personally liable for all debts and legal actions held against the business.
- A General Partnership consists of two or more individuals who agree, in a written contract, to manage the business and share in its profits or losses. Like a Sole Proprietorship, under a General Partnership, each partner is personally and legally liable for debts and legal actions against the business.
- A Limited Partnership (LP) is comprised of two or more general partners and one or more limited partners. The general partners manage the business and share fully in all profits and losses. The limited partners share in the profits but are limited in the losses to the extent of their investment and are normally not involved with the management of the company.
- A Limited Liability Partnership (LLP) is like a General Partnership but the partners do not have personal liability for the negligence of the other partners. This structure is favored by doctors, lawyers, CPAs, and other professional businesses.
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- A Limited Liability Company (LLC) is a common structure used by one or more individuals (or entities) through a written agreement. This agreement details the business's provisions for the management and distribution of profits and losses. LLCs can engage in any type of business except banking and insurance and the owners are limited as to their liability.
- Corporations - The law views a corporation as an entity separate from its owners. It has its own legal rights, independent of its owners, which are shareholders in the organization. They are more complex and costly to establish and require extensive financial and tax reporting vs. other structures.
S- Corporations, provides for very limited liability on the owners who are shareholders. These shareholders share in the profits and losses based upon the number of shares held by each and are reported on each shareholders personal tax return each year. The S-Corporation provides for more liability protection than an LLC or Partnership.
C - Corporations are large organizations whose ownership shares are normally publicly traded on an exchange. Owned by shareholders C Corporations are taxed as separate entities and can retain earnings which an S - Corporation can not.
Most start-ups structure as LLCs or Sub S Corps. which provide for limited liability on the part of the owners - with the Sub S providing an additional level of liability protection.