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How to choose the right business structure for your startup

Posted by Shivali Anand

September 13, 2021    |     3-minute read (895 words)

Your business may have started in your garage or a spare room. But eventually, your startup will grow beyond a hobby and become a financially viable entity. 

When it comes time to register your business, the many available types of legal structures from which to choose can be dizzying. Your selection will determine everything from taxes to how much of your personal assets are risk, so think carefully before deciding. Below is a recap of the various structures you must get familiar with to make an informed decision.

Sole proprietorship

With the sole proprietorship structure, you maintain complete management of your firm. But it doesn’t separate your business assets and liabilities from your personal ones. That means you can be held personally responsible for the debts of your business.

Some sole proprietors run into problems getting business financing, and sole proprietors cannot sell equity. You can, however, get a business name assigned to your company so that you don't only work under your own name. Anybody who does business without registering as another company structure will immediately be deemed a sole owner.

Partnership

You can consider starting a limited partnership or a limited liability partnership if you partner with one or more individuals.

The difference between a limited partnership and a limited liability partnership is that in the latter, one general partner has unlimited liability, while the others have limited liability.

But with a limited liability company, typically the owner is personally protected from personal liability. That means your personal assets won’t be at risk if your LLC were to default or be the target of a lawsuit. 

The Small Business Administration advises that "partnerships can be an excellent solution for firms with numerous owners, professional organizations (like attorneys), and groups who wish to test their business idea before forming a more formal business."

LLC

As the owner of an LLC, you are deemed self-employed and must pay self-employment tax as well as Social Security and Medicare contributions. Profits and losses are personal income not subject to corporate taxes.

LLCs can be a good option for medium- or high-risk businesses, owners with substantial personal assets they wish to safeguard, and entrepreneurs who seek to pay a lower tax rate than they would with a corporation, according to the Small Business Administration.

C corporation

The C-corp is often more expensive to establish than the other types of structure. But the C-corp allows you to legally separate the firm from its owners, providing substantial liability protection.

If you decide to start a C-corp, you should be prepared to set up effective operating processes, recordkeeping and reporting. You will need to pay income taxes on the company's profits (and, if applicable, taxes on dividends paid to shareholders), but you can generate money by selling equity if you wish. If an owner leaves the company, you can usually proceed with conducting business as usual.

If you want to generate money, go public or get acquired, a C corp may be the best option for you. But be apprised that double taxation may occur if a C-corp generates a profit for the year and allocates that profit to shareholders via dividends. Profits are taxed at the corporate level and then by the recipient of dividends individually.

S corporation

The S-corp permits its owners to avoid being taxed twice, unlike a C-corp. Profits and some losses can be carried through to the owners' personal income without being subjected to corporate tax rates.

All shareholders are required to be U.S. citizens, and the company cannot have more than 100 shareholders. If a shareholder sells their shares or leaves the company, the company continues to operate normally.

The SBA states that "S corps can be a good choice for businesses that would otherwise be a C corp, but meet the criteria to file as an S corp.”

B corporation

The B-corp, or benefit corporation, is treated taxwise the same as the C-corp, but these enterprises are motivated by profit and mission. In addition to profits, the B-corp is required to produce a public benefit, and some states require these companies to file yearly benefit reports.

You may not have to pay a third-party certification agency to register as a B-corp if the legal status is offered in your state. However, such firms may be able to assist you with the necessary paperwork.

Nonprofit

This structure might be appropriate if your company was founded to perform charity, educational, religious, scientific or literary work that is beneficial to the public. Nonprofits may be exempt from paying taxes, but they must apply for this exemption with the IRS separately from registering with the state.

These businesses are limited in what they can do with their revenue, which means they can't distribute them to members. Nonprofits are sometimes referred to by their IRS code, which is 501(c)(3).

Co-op

A cooperative is owned by the individuals who use its services; co-op members can purchase shares, but all members have equal voting power. The most distinctive feature of a cooperative is that profits and earnings are shared among members.

Members usually have voting rights over the co-op's operations, while a board of directors is generally established to set the rules.

Check the laws in your area

Prior to registering your business, obtain the applicable local regulations in the area where you intend to register. 

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