Do you want to know what type of business structure is best? Choosing a business legal structure for your new company is an essential step that begins with being well-informed.
There is a reason that the term ‘business structure’ is vital in business. The way you choose to arrange your new company will impact every aspect, from day-to-day tasks and operations to paying taxes and liability. Each unique business thrives under a different structure, and you should be on the lookout for the right mix of specific benefits and legal protections.
Here, we will go over the most common structures, discuss how some systems can be combined to increase benefit, and, most importantly, compare the ins and outs of different structures so that you can choose the correct fit.
Business Structure Overview
Did you know that the way in which you structure your business impacts the amount of tax you pay and your capacity for raising funds? The structure also dictates which essential documents you will need to file and the nature of your own personal liability. These are all integral parts of your business plan, so make sure that this is a measured, informed decision.
Choosing a business structure is not only important to the life of your new company; it is required before you formally register with the state. You will also need to get a tax identification number and file for permits and licenses.
Choosing the right structure is the first step in getting your business off on the right foot. Use the information here as a guide to familiarize yourself with the different business shapes, and think honestly about what you want to accomplish in the business world.
Can you change the structure of your business at some point? Yes, however, your location will dictate if there are restrictions to contend with, and there may also be tax consequences and other issues such as unintended dissolution.
We hope this article helps you in the process. Still, if you have questions, it makes sense to consult with our Business Lawyers & Corporate Attorneys at Nakase Wade.
Easy to form, sole proprietorships provide the entrepreneur total control. If you commonly complete business tasks but have not registered as another type of business, you are automatically seen as part of a sole proprietorship.
However, if you form this type of business, you are also not considered a separate entity. Therefore, your business liabilities, as well as assets, are not separated from your personal liabilities or assets.
Under a sole proprietorship, you are considered personally responsible for the obligations of the business, as well as its debts. This is a key point and a way in which this structure differs from others.
Sole Proprietorships can still secure a business name, but it can be difficult to gather funding because you cannot sell stock. Banks are often hesitant, too, to lend money to these types of businesses.
When is this the right choice? Sole proprietorships can be a solid structure for low-risk companies and for owners who want to try out their company’s ideas before creating a more official business structure. If this appeals to you, then your business might be the right candidate for a sole proprietorship.
In the simplest business structure, partnerships are reserved for two people—or more—who want to go in on an entity together. Limited liability partnerships differ from limited partnerships in a few key ways, so let’s look at which choice might work for you.
Partnerships with limited liability provide this right to each partner in the business. Therefore, each partner is protected from debts incurred against the company, so business partners are not accountable for actions belonging to the other partners.
Limited partnerships are similar, but they possess only a single partner who has unlimited liability. The other partners still possess limited liability. Also, the partners whose liability is limited generally only have limited power over the business, as documented in the agreement of partnership. In this structure, any profits “flow-through” to the partners’ personal returns, and the partner who has unlimited liability needs to pay taxes for self-employment.
When are partnerships a beneficial choice for your new business? Partnerships are a solid option for companies with several owners, professional groups such as attorneys, and, like a sole proprietorship, entrepreneurs who would like to test out their businesses first.
Partnerships can also be a good choice for businesses with multiple owners, professional groups (like attorneys), and groups who want to give their business a “soft opening” and see how it does before forming something more permanent.
Company with Limited Liability (LLC)
LLCs are known as a “mix” of the elements of partnerships and corporations. This is because LLCs protect owners, in most cases, from personal liability. This means if your business flounders and faces bankruptcy or legal action, your personal effects such as bank accounts, vehicles, or houses will not be risked.
How is this possible? Your profits, as well as losses, are passed through into your personal income, and there are no corporate taxes applied. However, LLC members must pay taxes towards Medicare as well as Social Security since they are considered to be self-employed.
It is important to remember, though, that if you decide on an LLC, there may be limits on your company’s lifespan in some states. For example, in some states, your LLC must be dissolved and then re-created with new members when a member either leaves or joins the business. However, there is a way around this: some LLCs already have an agreement placed within the LLC that deals with the transfer of ownership, selling, and buying the business. Our recommendation is to investigate your state’s terms before you open up your LLC for business.
Based on some of the clear advantages that LLCs offer, their popularity is understandable. However, this business structure is not advantageous for everyone, so weigh your options carefully. If you would prefer a tax rate that is lower than that of a corporation, and if you have noteworthy personal assets that you would like protected, this may be a top choice for you to look into. Also, if you consider your business to be in the medium or high-risk range, an LLC could be right for you.
Corporation: C corp
A C corporation, often referred to by the nickname C corp, can be a strong choice for many business owners. Legal entities that are considered separate from their owners, C corps are legally liable, taxable, and can create a profit. They also provide the greatest protection from personal liability for their owners.
However, C corps cost more money to form as compared to other business structures, and they require more work to maintain: for example, you’ll need to conduct extensive reporting and keep careful records.
Dissimilar to the other business structures we have looked at, C corps must pay income taxes on profits. Sometimes, a corporation’s profits are taxed not once but twice. First, they are taxed when the business turns a profit. Then, they are taxed additionally when the dividends are paid out to shareholders on their tax returns.
Additionally, corporations such as C corps are considered independent from shareholders. This simply means that if one shareholder sells his/her shares or even leaves the business, the corporation can proceed with business with little to no disturbance.
One key advantage that the C corps hold is this: raising capital can be easier. Corporations can raise funds through selling stock, and this trait can be attractive to prospective employees if you are looking to grow your business.
Each of these business structures is unique, and we are identifying the key differences in order to help you choose. Keep in mind that just like the other structures, C corps are not for everyone. However, if your business plans to “go public” or you anticipate selling it eventually, this might be a solid choice to look into. C corps are also beneficial for businesses in the medium-to-higher risk range, as well as those businesses that are looking to raise money. So, if raising capital is the main concern, and your business lines up well with the other categories, this might be the top choice for your new company.
Corporation: S corp
Sometimes referred to as S corps, S corporations possess some interesting characteristics. S corps are uniquely designed in order to prevent the ‘double taxation process that C corps are vulnerable to. How is this possible? S corps allow profits and even some losses to flow through directly to the owners’ own personal incomes. Therefore, these profits and losses are not subject to the corporation’s tax rates.
Importantly, S corps are not taxed equally in all states. However, most states recognize S corps in the same way that the federal government does. It is important to check in with the state you will be doing business in since some states do tax S corporations on certain profit margins. Other states simply do not recognize the S corp structure and treat S corps in the same way as C corps.
Like C corps, S corps have a life outside of their owners, so if a member sells their shares or leaves the business, the company will live on and be able to continue with business with little to no disturbance.
This type of business structure can be a good fit for your company if your business is in the C corp category but is able to meet the terms of an S corp. If you are considering this structure, keep in mind that there are some special limits to contend with. For example, you will have to file with the Internal Revenue Service to attain S corp status, which differs from the process required by the other arrangements. If you do select S corp status, also remember that you will have to adhere to the operational and filing processes and requirements of a C corp.
Corporation: B corp
An additional business structure for new business owners to consider is that of a B corporation or B corp. Recognized by most U.S. states, B corps are for-profit corporations that differ dramatically from C corps in some ways, but not all. In terms of purpose and transparency, as well as accountability, B corps (also known as Benefit Corporations) are unlike C corps. However, both types of companies are taxed in the same manner.
Driven by profit as well as mission, B corporations are held accountable by shareholders, who expect the creation of a public benefit as well as the typical financial profits. Therefore, some states will require proof of this donation to a good cause in the form of annual reports.
If you are interested in both running your business for profits and the good of the public sphere, first check to see if B corp legal status is available in your state. If not, there are also numerous third-party certification services for B corps that you can investigate.
Similar to B corps, Close corporations are able to espouse many of the formal traits that routinely govern smaller companies as well as corporations. This is because Close corporations possess a less traditional structure. These corporations do not exceed a regulated number of shareholders and are not considered public. The number of shareholders depends on the business laws in the state. Close corporations can therefore be run by a smaller number of shareholders than the other structures we have looked at, and sometimes without directors sitting on the board as well.
Nonprofits or 501 (c)(3) Companies
You may be aware that Nonprofit organizations, similar to B corps, are dedicated to the public good in various ways, such as providing charity, contributing to education, or aiding in religious or scientific work. Because of this key difference, nonprofits can be tax-exempt. What does this mean? It simply implies that Nonprofit corporations are not required to pay federal or state taxes on their profits.
In order the attain this exemption, Nonprofit companies file with the Internal Revenue Service. If you are interested in forming a Nonprofit, pay attention to the details: these corporations must adhere to certain rules similar to those of the C corps, but they also need to follow specific requirements regarding their earned profits and what they can and cannot do with them. For example, profits cannot be distributed to a political campaign or to members themselves.
Did you know? We often call Nonprofits 501(c)(3) companies. This is in reference to the IRS Code section that is used for tax-exempt status.
Cooperatives are businesses that are operated for the benefit of those who are using the services of the company. Therefore, the owners who operate the company (also known as user-owners) will see the earnings of the company distributed to them.
Usually, a Cooperatives is governed by its officers and a board of elected directors. Also, normal members of the business possess the voting power to control the company’s direction. How do members become a part of the Cooperative? They simply purchase shares. It is interesting to note, however, that the amount of shares a member owns does not change the power of their vote in the business.
It is interesting to note that S corps and Nonprofits are not only business structures, though that angle is what we have focused on here. But, each of these unique designations can be understood as tax status. Therefore, it is possible to tax an LLC as an S corp, a C corp, or even a nonprofit. These arrangements are less common than the traditional ways of doing business and paying taxes, and they can be challenging to structure initially. However, every year, new companies decide to challenge tradition and try something new, and sometimes it pays off. If you are interested in a non-traditional structure for your company, we at Nakase Wade can help. Our Business Lawyers & Corporate Attorneys are here to provide expert consultation regarding your new LLC, Nonprofit, or S or C corp.
Time to Choose a Structure
We hope this information has been helpful and will make the important decision regarding your new company easier. Deciding on a business structure is one of the most important aspects of forming your new venture.
As you compare the different advantages and disadvantages here, keep in mind that each state has its own rules of ownership, taxation, filing, and liability. Likewise, the process involved in starting up a new company differs in each state in terms of documents to sign, forms to fill out, important dates and deadlines, and fees.
For questions about choosing a business structure or forming a new corporation in California, please get in touch with our skilled business lawyers and attorneys. Whatever structure you choose, good luck with your new business.