Picture this. You have an idea – one that you are passionate about. Recently, you have realized that this idea could be a source of not only fulfillment but financial gain. This is the beginning of your journey as a business owner, and it is difficult to know where to begin. After all, there are so many possibilities that come with an overwhelming number of state and federal regulations.
Fortunately, there is a perfect Step 1 that could effectively narrow down the requirements and provide a springboard for your venture. Choosing an entity type that best fits your business will allow you to tailor your business structure to fit your vision as well as you fit in your favorite pair of jeans.
A partnership could provide you with allies in your pursuit of success and a defined agreement that details how your business operates while allowing you to avoid burdensome regulations and filing requirements.
Establishing a partnership is easier than you think – it simply requires two or more persons carrying on business together for profit. Technically, there’s filing necessary, but that means you could create a partnership by accident! Partnerships are still not officially recognized as legal “entities”, but rather a type of business structure between two or more individuals. However, regardless of the lack of official filing requirements, when operating as a partnership, it is very important to create a Partnership Agreement that establishes the requirements of being a partner and operating the business.
The flexibility of a Partnership Agreement allows you to tailor your business to your preferred specifications including things like management structure, profit and loss sharing, and capital contributions (investments) you make to the partnership.
One of the most attractive things about a partnership is the availability of pass-through taxation. This format allows the partners to avoid double taxation and only pay taxes on your individual tax filings.
On the other hand, general partnerships (the ones you don’t technically have to file for with the State office) can be tricky due to their high risk of personal liability. The good news is that there are other types of partnership structures that can combat the significant personal liability, such as Limited Partnerships or Limited Liability Partnerships.
Continuing with the topic of avoiding personal liability, a Limited Liability Company – or LLC – could be the perfect option for your blossoming business idea.
An LLC combines many aspects of different types of business structures, cherry-picking the “best of the best! Much like a partnership, an LLC has a great deal of freedom and flexibility to structure the business through an Operating Agreement (this is just the LLC’s term for a partnership agreement). LLCs also qualify for pass-through taxation. However, unlike a partnership, an LLC is a recognized legal entity which allows property and real estate to be purchased in the name of the LLC, rather than the individual members.
The most important difference that makes an LLC so attractive to a new small-business owner is the escape from personal liability. An LLC protects its members from being personally liable for the debts of the business or the other members. This can provide much needed peace of mind when a new business is first getting off the ground; investors can invest without risking the loss of all of their other assets.
LLCs are also attractive due to their perpetual existence. Unlike a partnership, an LLC can continue to exist after all original owners choose to leave the company or die. This provides stability within the management structure and allows business owners to realistically create a long-term plan for their new enterprise.
In contrast to a partnership and one of the few downsides to choosing this entity structure, LLCs do require formation filings and formalities as well as yearly renewals. However, this can be easily maintained by hiring an attorney to act as your Registered Agent and handle your yearly renewal requirements!
For some lucky new business owners, their growing idea best fits with a corporate structure. Corporations are more complex than the previously mentioned business types, but with that comes some definitive benefits.
A corporation not only provides limited liability for the owners, but also a very high potential for growth and expansion. This type of entity (Yes, corporations have entity status!) is organized with more of a hierarchal structure of management, split between the shareholders, the board of directors, and the executive officers. Through this structure, corporations can operate efficiently while also covering a lot of ground.
A corporation is required to have a formation documents, such as Shareholder Agreements, Organizational Meeting Minutes of the Shareholders, Articles of Incorporation, and the Certificate of Incorporation. These documents serve similar functions to a Partnership Agreement or an Operating Agreement, but corporations are required to have and file most of the documents rather than just having the option to.
This requirement brings us to the first undesirable characteristic of corporations. They require a great deal of filing in addition to compliance with corporate formalities. The bigger and more complex the corporation is, the more formalities must be followed, and formalities mean legal work (which can get pricey).
However, the filing requirement is equalized for some by the fact that the formalities allow business owners more flexibility! They can issue shares easily, hold legally binding meetings amongst shareholders and directors, and – eventually – even take their corporation public and sell it on the NY Stock Exchange! This also contributes to another benefit of corporations – it is much easier to garner investment and gain capital by selling shares of stock in the company.
Arguably the greatest burden of filing as a corporation is that corporations are (normally) double taxed. The company makes money, the company gets taxed on that money, and leftover money is distributed to the shareholders, who are then taxed a second time! This can be avoided should an entity file to qualify as an S-Corp with the IRS. Filing as an S-Corp allows a corporation to avoid this double taxation pitfall, but the requirements are quite specific and they also limit the number of people who can own the corporation.
In conclusion, one of the most important decisions that an aspiring business owner makes is determining what type of structure will work best with their short-term and long-term business goals. Comparing and contrasting the most common types of businesses will help you and your team decide how to move forward from the start so that you can more easily reach your goals.
This blog was written by Mackenzie Lintz Coleman and Jonathan Sparks. If you have any additional questions please contact either of them and they’d be happy to help!