How to Choose Which Type of Legal Structure is Right for Your Business

When you start building your business, there are so many
crucial questions you need to answer from the very first steps
you take into the entrepreneurial world. However, a top
priority among them should be choosing the suitable legal
structure that will both protect your private and personal
assets, and allow for the growth of your newly-founded
business, in accordance with the local, state and federal law.

Your choice will affect numerous aspects of your operation –
from tax benefits and obligations, the level of liability, the
boundaries between your personal and business assets, all the
way to the amount of paperwork you’ll need to handle on a
monthly and yearly basis. If you’re still wondering what the
best solution would be for you, take a look at these basic
legal structures to consider for your business.

Sole Proprietorship

Considered the simplest legal structure that requires
conveniently little paperwork, a sole proprietorship is a
form that is demanding for your energy, as well as your
business savvy, since the basic premise is that you are the
sole owner and manager of your operations.

It also means that there is no viable difference between you as
an individual, and your business, making you solely responsible
for your potential business failures, so you need to be aware
of the level of risk you are assuming with this structure.
Since you are the business entity, you will be held accountable
for all debt and losses that might occur during your company’s
existence.

Bear in mind that this structure might hold a different name in
various countries, so it can be loosely translated as “sole
professional” or “sole entrepreneur,” and it might include
different taxing strategies, so make sure to be well informed
before you settle for this solution.

Depending on your expertise and education, there could be
various intricacies involved in obtaining proper licenses and
protecting trademarks to
make your business entirely legal and operational. For
instance, if you are a medical professional, different
countries require different levels of academic qualifications
for obtaining a sole professional license.

On the other hand, if you are a freelancer who wishes to
legalize their services, you would likely fall under the
category of micro-entrepreneurship.

But look to your community – how many artisans and various
service providers do you know that still create quite a buzz in
your business world and earn a sizeable income solely on their
own creative output and individual efforts? They might seem
unimposing, but they certainly know how to make it in the
market with a unique offer and plenty of hard work.

On a final note, make sure to comply with all the laws and
regulations while setting up your business, and while most of
the essential information can be obtained from your local
business development center; you might wish to consult a legal professional to
guide you through the process.

Partnerships

If you decide to expand your business or if the original idea
was the result of mutual efforts, then it makes sense to
form a partnership with one
or more parties to share the responsibilities of your company.
However, before you form a partnership, you will need to
establish clear boundaries of responsibility, how you will
share profits and losses, how you will handle decision-making,
future employment, as well as the development of your business.

It goes without saying that trust plays a pivotal role in
forming a partnership, as legally-binding contracts and
mutually-beneficial strategies alone cannot be the sole basis
of your future endeavors. You need to share the vision, goals,
and beliefs for your business to succeed. Therefore, strive to
establish a clear line of transparent communication and clear
lines of authority.

Just like with sole proprietorship, partners share liability
when it comes to potential losses and debts, which is
considered as a disadvantage to this structure, but it can be
easily manageable if you build your business on a strong
foundation and with a clear short term and long term plan for
accelerated success.

A shining example of a partnership that allowed for a soaring
revolution of their business is The Baker Chocolate Company
founded by chocolatier John Hannon and his partner, Walter
Baker who was in charge of the business portion of their
operation. Today, they are known by the name Mondelez
International – need we say more?

Corporations

As a more complex and pricier structure, a standard C corporation is recommended mostly for already
established businesses that include several involved parties as
well as employees in some instances. It takes more time, money
and paperwork to form a corporation, and it is considered as a
separate entity although it consists of several people, much
like an individual, and is treated as such in the eyes of the
law.

The main perk of this structure is that the liability of each
shareholder (or member, whether the corporation is stock or
nonstock) is limited to the investment they made in the company
while protecting their personal assets. That means that in the
case of a debt or loss, the private assets of each shareholder
are protected by law.

While this structure allows for an infinite number of members
or shareholders, it still has certain drawbacks. Unfortunately,
a typical corporation’s annual profits are taxed on a corporate
level, and then once again as the dividends are shared among
the stakeholders, which is known as double
taxation, making this structure less appealing for
businesses, especially those who are at the very beginning of
their professional journey.

S Corporations

On the other hand, since the issue of double taxation is
commonly perceived as the main setback of forming a C
corporation, as the company’s profit is taxed both on a
corporate and on a personal level of each shareholder; you can
look for a different solution. This two-layer system causes
many businesses to opt for a variation called the S corporation, or the Subchapter Corporation
which avoids the double taxation while keeping the perk of
limited liability.

This calls for each shareholder to file their income taxes
individually and report their profits and losses accordingly,
which makes it similar to the operation of a typical
partnership.

Unlike a C corporation, an S corporation can include no more
than one hundred members, who are all individuals and legal
citizens of the country of the company’s origin. Provided that
all of these conditions are met, then a C corporation can
transition into an S corporation.

LLC – Limited Liability Companies

Another variation that protects you from the taxing issue is
forming an LLC, also known as a limited liability company. An LLC is a kind
of a hybrid partnership, as it holds the same benefits as a
corporation, keeping its members protected from liability, and
a single taxation layer typical of a partnership or a sole
proprietorship.

However, despite this structure’s simplicity in terms of
initial formation and setting up, unlike a regular C corp which
can last in perpetuity and outlive its members, an LLC needs to
be dissolved upon bankruptcy or a member’s passing.

Certain professions, such as medical or legal that need
specific licenses to be established, may not be allowed to form
a standard LLC, but they can qualify for a variety of this
structure also known as the professional limited liability
company, or PLLC.

Nowadays, even a single person can form an LLC instead of a
sole proprietorship, so having multiple members is not a
prerequisite for this structure, making it even more appealing
for startups and new business owners. The flexibility of an LLC
along with its hybrid blend of limited liability of a
corporation along with a partnership’s pass-through income
taxation offers plenty of room for growth and development for
modern businesses.

However, limited liability should not be construed as complete
protection of personal liability. For instance, few business
owners realize that they can still be sued personally for the
service they have provided, without involving the entire
company. A surgeon can be held legally accountable for making a
mistake without implicating the whole private practice.

How to Choose Between the Business Structures

While all of these structures are viable options and have their
own benefits and downsides, you will need to consider several
relevant criteria before settling for your ideal legal
solution. Also, bear in mind that you might want to change your
business structure after a certain amount of time, so you will
need to educate yourself on the prerequisites for a business to
make the switch.

Financial Requirements

Learning about running a different business structure might
seem like a tedious task, but it’s necessary to establish
whether or not you can afford a certain structure, to begin
with, and how your long-term goals coincide with the specific
legal conditions of your country of residence.

For starters, the sheer price and complexity of record keeping and
administration costs can be quite overwhelming for a
startup. You will need to assess how much of these
necessities your investment can cover, and whether or not you
will need to hire a professional bookkeeper if you are not
qualified to be one, to keep your business administration in
order to a reasonable fee.

In general, all forms of corporations need more financial
support regarding their paperwork and ongoing management,
unlike the simpler sole proprietorship or a partnership, which
makes the latter two a very popular choice for startup
companies who are looking to grow their business slowly before
diving into the corporate world.

Then again, such a choice involves dealing with insurance
policies that are meant to protect your initial investment and
cover your losses in case of unexpected events, whether your
physical or intellectual goods are at risk.

Think Long-Term

No matter how tempting and exhilarating it is to devote all of
your energy and enthusiasm to creating what is in your hands at
this very moment, every successful company can thank its
long-term strategic planning for
its growth. While your decision will be mostly determined
by the factors that seem most appealing and make the most sense
right now, you need to assess your business’s future viability
and growth potential before you make up your mind.

If you are starting out alone or with a partner, and you are
deeply invested in your idea, then the notion of sharing the
ownership someday might not be as appealing now, while it might
become a necessity or a greater good for your business
somewhere down the road. And while the question of your
business’s existence after your demise might not be on your
mind now, it is yet another determining factor that will form
the future direction of your business, and that decision alone
can affect your future partnerships, investments as well as
your overall success.

Another influencing factor is your perception of other
companies’ success, so you could be tempted to follow in their
legal footsteps and apply the same or similar principles to
your internal organization. While this is a reasonable factor
to count in, it should be far from determining when it comes to
landing on your final choice.

What has worked in the past for your predecessors and
competitors might not be a viable solution for your business,
and you need to evaluate this possibility while objectively
comparing and contrasting their success with your goals,
without letting it cloud your judgment.

Level of Flexibility

A commonly overlooked aspect of any business, the flexibility of your
business needs to be predetermined by your expectations,
legal freedoms as well as your potential partner’s needs.
Although most of your operational rules and regulations will be
clearly presented in the form of a contract, there are certain
unwritten rules that every business needs to consider before
setting up.

A rigid ownership will often allow little room for development
and growth, while an organization that is too loose and open
can, on the other hand, expose your business to certain risks.

In the case of a partnership, it is then essential to outline
yours and your partner’s’ legal, personal and shared
responsibilities, authority and expectations in a Partnership Agreement. Such
a document should contain all the relevant information
regarding your investment, and not just financial, but
regarding ideas, business opportunities, connections, effort,
etc.

Daily duties should also be clearly established, while all the
hypothetical situations and possible problems in the future
should also be considered beforehand. What would happen to your
business should your partner decide to pursue other interests,
become disabled or pass away? How will you handle any potential
conflicts and reputation risks and client relationships?

All of these and many more questions will determine the level
of flexibility of your company, as well as its potential to
outgrow its starting point.

Tax Options

As you’ve seen so far in each structure’s brief overview, every
one of them offers a different tax system, which is another
significant segment of your business and determines how well it
can thrive and become profitable.

While you might start out as a sole proprietorship or in a
simple partnership, and you’re far from worrying about double
taxation, you should reflect on your business’s future path and
how far down the road you might wish to incorporate, and
whether or not you would qualify for an S corporation, and what
you need to do to ensure this option.

There are numerous options to avoid double taxation and
unnecessary losses in the form of federal taxes, so you should
carefully map out your company’s long-term steps and fallback
options, as well as monitoring your ongoing progress so that
you can protect your initial investment, personal assets as
well as your future income.
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Liability

If your business involves expensive equipment, complicated
procedures, or even affects the wellbeing of others, your
business will be at constant risk of not only lawsuits but from
accidents, damage, jeopardizing your reputation and finally,
losing your personal possessions to cover your business losses.

That is the principal reason behind most decisions to
incorporate, as both you and your potential partners would like
to do their best to avoid or at least limit their personal
liability. In the case of a legal issue, losses or debt, then
your private property and assets are protected by law, which is
a major element for most high-risk businesses, as well as those
that have much to lose while working with large contracts.

Conclusion

Most of these complex decisions will be largely influenced by
your field of work, so not even the best and most successful
existing businesses can be used as a bulletproof strategy to
ensure your success. Even the greatest among modern businesses
such as Google might have had humble beginnings – somewhere in
a dorm room and stuck in a basement behind a less than adequate
computer, but with a brilliant idea, plenty of determination
and hard work to back up their dream and ingenuity.

If there’s anything you can learn from their success, it is
that you need to let go of the desire to follow in their
footsteps, but create your path, including the very essentials
such as the legal structure of your business, to allow your
vision to thrive and succeed.