You’ve identified a need in the marketplace that matches your skill level or expertise, and you’ve decided to start a business. Congratulations, but this is only the beginning. Once you’ve established your business concept and are officially ready to get started, it is time to structure your business. Like all things in business, you have many choices. Let’s briefly review your options.
This is the easiest way to get started as a business owner, but it also has the most liability. It does not separate you from your business. Sole proprietors don’t need separate tax IDs for their business; instead, you use your social security number because the business and your personal affairs are connected. Solopreneurs, or freelancers, just starting might opt for this structure because it is easy to get started and has the least amount of out-of-pocket costs to start. However, you would still liable for self-employment and personal taxes.
Limited Liability Corporation (LLC)
The LLC is often the most recommended structure for a new business because it separates your personal assets from your business. In essence, it protects your personal assets in the event you are sued. The liability stays with the business and not you as a person. In most businesses, you will assume some level of liability with your customer so if there is even a remote chance a customer could sue for anything, this option will help protect your assets.
Another benefit of going the LLC route is to take advantage of “Pass-through” federal taxation. This means, your business’ profits are reported on its members income tax, and are not subject to corporate taxation. This makes filing easier because if your business loses money, you and other members can shoulder the hit on your own personal tax return that will lower your tax burdens.
Like the LLC, Corporations are a separate legal entity, so your business stands on its own. The cost to set up a corporation is higher and is usually reserved for a business with more than one or two people with the intention to scale. Corporations must keep more “extensive record keeping” and they also pay income taxes on their profits. The corporation is separate from its shareholders, meaning it can continue doing business as usual should one leave the company. Many companies opt for this structure if they are seeking funding or have plans to seek funding soon.
This structure is exactly as it suggests. This is the simplest structure to organize if your business is owned by two or more people. While the LLC may be good for a couple of partners, businesses benefit the most when there are several partners or a group with this structure in place. Businesses often use this structure as a test to determine if their business is a fit for a corporation or S Corp.
S Corporation (S Corp)
S Corps are like Corporations, but the key benefit lies within its tax structure. S-Corp businesses can avoid double taxation, whereas Corporations can't. There are special requirements to qualify for the S Corporation and it must be filed differently than the Corporation (see here), but it can be a great option if you meet the criteria.
B Corporation (B Corp)
This unique structure is driven by both purpose and profit. Though it is a "for-profit business", the B Corporation is like a blend of a nonprofit and a corporation. The shareholders are responsible for producing a public, mission driven benefit in addition to the company profit. There are no certifications required to file for B Corporation although some state requirements may vary.
Unlike the B Corporation, nonprofits are 100% mission driven, and are eligible to file tax exempt on state and federal returns as a result. Although this may be a huge benefit, nonprofits have rules they must follow regarding profit distribution. For example, profits cannot be distributed to members of the organization. Instead, profits must be displayed publicly so donors are knowledgeable of how their contributions are used.
There are a lot of considerations when choosing which structure is the best for your business.
If you are just getting started and you’re not sure which way to go, the LLC is almost always a good start. The reason for this is it protects your business from your personal life. You want your business to stand alone and eliminate any liability on your personal assets.
As you’re structuring your business, protect your intellectual property. Even if the only intellectual property you own is your phone number and your website, consider establishing a trust to separate this from your business entity for protection. Additionally, if you are considering funding, whether from a bank or an investor, this will affect your business structure.
Starting a new business is exciting but it can also be a very daunting process. You do not have to go at it alone. VAAS Professionals has been working with small businesses for over 20 years to advise them on critical decisions like their business structure. We would be happy to set up an introductory consultation to walk you through this process.