Before you can start building momentum in your business, you’ll need to finalize your business structure, which is a major decision that afflicts many business owners with analysis paralysis. In the United States, there are many different business structures to choose from, including sole proprietorships, partnerships, LLCs, corporations, and alternative structures like LLPs and S-corporations.
Each one has its own strengths and weaknesses, and is tailored to a different type of business overall, so there’s no one “right” business structure. So how are you supposed to choose which one is most appropriate for your business?
What to consider
Obviously, you’ll need to have a good understanding of what your business is about before you make this decision. At a minimum, you should have a fleshed-out business plan, with a clear idea for your leadership, your industry, and how you’re going to make money. For example, the size and reach of your business will play a role in how you structure it, as will the number of people you plan to have in charge—so it pays to be familiar with these variables in advance.
1. State-level variations
First, you should know that the types of business structures available to you will have rules and restrictions that vary by state. For example, each state has slightly different taxes, fees, and requirements for how LLCs operate. Depending on the nature of your business, you might be able to establish your business in a state other than the one in which you reside, so it pays to know the advantages and disadvantages of forming your business in each possible state.
2. Taxes and fees
One of the biggest practical factors for your consideration is going to be how taxes and fees work for your business structure. For example, in a sole proprietorship, you’ll pay taxes as an individual on any income you make in the business. In a corporation, your business will be treated as a separate entity, responsible for paying a corporate income tax rate on top of an individual tax rate when you recognize profits—but you can use tax-planning to your advantage. Some states also impose annual fees for certain types of businesses.
3. Paperwork and regulations
Some business structures are more complicated than others to start, operate, and maintain. For example, most corporations are complicated business entities that require extensive paperwork to start up, and annual reports to be filed every year. Corporations are also subject to many other rules and regulations, which vary by state. In general, the simpler the business structure, the easier it is to maintain, and the fewer regulations it’s going to face. Sole proprietorships and partnerships are generally easier.
4. Liability and protection
Different business structures offer different levels of liability protection. For example, sole proprietorships and partnerships offer virtually no liability protection; if you do something illegal or inappropriate in your business, you’ll be subject to the full consequences of those actions, no matter what. In a corporation, the business is treated as a distinct legal entity, and if it violates a contract or a copyright law, in many cases, the corporation will be subject to liability—not the individuals in the company who made the decision. This isn’t always true, but it’s worth noting. Corporations offer the most liability protection, while LLCs offer limited liability protection (as the name implies).
5. The future of your business
Finally, think about how you expect the company to grow. Sole proprietorships and partnerships are useful, simple structures ideal for small businesses. But if you plan to open and manage many locations, hire lots of employees, or expand to have a national presence, you’ll definitely want an LLC or a corporation. Corporations also have the option of going public, issuing shares for public purchase as a way to raise funds; if you foresee the need to gain access to that capital in the future, it may be wise to start your business as a corporation now.
Some of these factors might take priority over the others, depending on your goals. For example, if you want the business to be as profitable as possible, you may consider taxes and fees more than the complexity of the business.
Finalizing your choice
It is possible to change your business structure in the future, but it’s much more efficient to make the “right” choice from the beginning. If, after reviewing all the legal requirements, advantages, and disadvantages of different business structures, you’re still confused about what to choose, consider working with a mentor, or talking with other business owners in your industry. They might be able to clarify some points and make a recommendation for the best business structure for your vision.