How to Choose a Small Business Structure That Sets You Up for Success
You’ve nailed your business plan and you’re ready to launch your own business. Woohoo! Go you! Or maybe you’re a freelancer and you're beginning to realize you need to get a bit more organized to manage expenses and taxes. Perhaps you’re getting so busy that you even need to hire an assistant or two. Or maybe you’ve been dabbling in a side hustle for a while, and you’re ready to go pro.
Whatever your path of small business growth, choosing the right legal structure from the start will make it easier for your business to grow and change over time. It will help you to streamline your finances and your taxes, and provide you with a blueprint for handling the changes your business will experience as it expands.
Common Business Entity Structures
First, let’s look at the most common business structures and what distinguishes one from another. In this article, we’ll cover:
Sole proprietorships
Partnerships
Limited liability companies
S-corporations
Sole Proprietorship
This is the simplest set-up for a small business and can work well for a solo service-based entrepreneur. A sole proprietorship provides guidance for how the business owners need to file their taxes, but it doesn’t require much extra legwork.
Perhaps you are a life coach, a freelance writer, or a photographer, or maybe you have a home-based business making jewelry that you sell online. If you work by yourself for the times and clients you choose, a sole proprietorship could be a good option to start with.
Partnership
Are you founding a business with a bestie or your spouse? Setting up a partnership entity is almost as simple as a sole proprietorship. A partnership is defined as a relationship between two or more people to do trade or business. Each person contributes money, property, labor, or skills, and shares in the profits and losses of the business.
Although there is an annual report to file, a partnership doesn’t require the company to pay separate taxes. Similar to a sole proprietorship, profits, losses, and taxes are handled via each partner’s individual tax form, making it less complex to get started.
Limited Liability Company
If your business will have assets, liabilities, or employees, setting up an LLC might be the best course of action. It offers the most protection for you as a business owner and helps you separate your business assets from your personal assets.
If you have a storefront, real estate, or require specialized equipment to do your work, an LLC can protect both you and your business and provide some tax benefits such as avoiding double taxation. Both sole proprietors and partnerships can form an LLC to protect their personal assets from any legal issues that may arise as a result of doing business.
S corporation
If you have an established business that is ready to grow, selecting an S corporation—or S corp—structure can help you to retain liability protection and enjoy more tax benefits. It’s also ideal if you would rather hand off business details and major decisions to a board of directors. A corporation is the most complex structure, requiring registration with state and local authorities, detailed record keeping and filings, and regular meetings with your board of directors.
An S-Corp is ideal for a small business as it gives the owners maximum liability protection while still allowing tax flexibility. It must be based in the US, and its owners US citizens. An S-Corp can be owned via a board of directors of up to 100 individuals who pay the company’s taxes through their individual tax forms.
How to Choose the Right Structure for Your Business
First of all, know that your business is as unique as you are. Choosing a legal structure that is right for you will give you a framework for making important decisions and help you focus on what you do best—growing your business!
With that being said, even though there are legalities in place, nothing is set in stone. You can always make changes to your business’s legal structure. Here are four questions to ask yourself to decide the best legal structure for your business:
How much risk can I tolerate to my personal assets?
How do I want to be taxed?
How much control do I want over business decisions?
How big do I expect to grow?
1. How much risk can I tolerate to my personal assets?
Sole proprietorships and general partnerships are not protected from legal action against their personal assets. If your company is sued and loses, the suing parties may be able to go after you and/or your business partners’ bank accounts, any property you own, and more. And if you default on a business loan, creditors may be able to go after your personal assets as well.
LLCs and corporations limit their owners’, members’, and shareholders’ liability, so that personal assets are protected from any legal action that’s taken against the business.
2. How do I want to be taxed?
For the most part, sole proprietors, partnerships, LLCs, and S corporations are considered pass-through entities. This means that business profits are passed directly to the business owners, who file and pay these taxes on their income tax forms.
S corporations offer the unique benefit of helping business owners reduce their self-employment taxes, as they are considered employees of the business. More complex corporations such as C corps require that businesses pay corporate taxes. Business owners and shareholders must then also pay income taxes on the profits they receive from the business.
3. How much control do I want over business decisions?
Some business structures are relatively simple to set up and manage, while others are more complex. Choosing a sole proprietorship or an LLC gives you the most control over every aspect of your business, whereas an S corp is required by law to have a board of directors to oversee the company’s direction on behalf of shareholders.
Of course, you can elect to structure your business as an S corp even if you’re the only person working inside and managing the business. But to do so, your business must meet certain requirements to do so.
4. How big do I expect to grow?
You may be starting small, but don’t be afraid to dream big and set up your business to match your vision. Will you eventually be hiring employees? Does your business serve your local community or people all over the world? Will you need funding now or in the future?
You can always change the legal structure of your business, but be aware that it might come with more work. Planning for the future will allow you to set yourself up for success from the beginning.
Work With a Financial Business Coach to Choose the Right Structure for Your Company
There are additional business structures that might suit your unique company better, and if you have a hunch that that’s the case, reach out for help! It’s also possible for your business to be a combination of structures or to change structures over time. If you're not sure, it's always best to consult with an attorney and accountant to help you decide and understand the pros and cons for your unique scenario.
At Financial Fitness Coaching, our team of coaches can help you understand and weigh your options and even put you in touch with legal and accounting professionals. To see how we can help you and your business email us at info@financialfitnesscoaching or simply schedule a free 20-minute Discovery Call on our calendar.