Structure Your Business
You have a great business idea, maybe you want to go into business with your friend. The first thing you should be asking yourself is how should you structure your business. There are multiple structure types that can meet your companies vision. This is a general snapshot of the possible business structures. An in depth breakdown to follow. Check out the book list for additional reading on forming your business structure.
Why Structure Your Business
You might be thinking this is more of an advanced matter. You want to get a business plan into action and just go. Just as a business plan is critical to starting, the business structure layouts out a strong foundation. If you set your business structure in the beginning, your business will grow properly into your vision. Image you have a puppy. You know you need to buy a crate, and since he is small, you can save money just going with the cheapest, smallest crate the will fit him. As he grows, you’re going to need to buy another crate, which takes extra time and money. If you would have just had the end game in mind, you could have bought the right structure from the get go.
Types of Structures
In the past, there were only three structures to choose from: proprietorship, partnership, or corporation. In the late 1980s, the limited liability structure was added. Now, there is a many structure, many seem like a combination of others, but for this, I will break down the following structures.
- Sole Proprietorship
- General Partnership
- Limited Liability Company
- Corporations
The LLCs and Corporations have subcategories that I will briefly describe. By the end, you should have a general sense of the direction you want to take your company.
Structure Your Business: Sole Proprietorship
This structure is the most common business structure that exists. It is a single-person unincorporated business model. It is also the easiest structure to create, maintain, and, when necessary, dissolve. All you have to do is start working. Say you wanted to design iPhone covers. You do the designs yourself, you get them printed and shipped to you, and you sell them. The company has no employees, it’s just you. You needed to do nothing, you’re just in business.
However, if you are building a brand, or selling as part of a brand, you will need to do a Doing Business As (DBA), which you register with your state government. This way, if someone writes you a check, you can cash it at your bank account. The biggest disadvantage to this structure is you have unlimited personal liability for everything regarding your business. If your product falls to a lawsuit, your personal assets are on the line. The benefit is your taxes go on your personal return. If this company is your only source of income, you may have to pay self-employment taxes that impact profits.
Structure Your Business: General Partnership
This structure is similar to the sole proprietorship in that is unincorporated, but it is with two or more persons/entities. Again, this entity exposes its owners to unlimited personal liability for all financial obligations of the company. It is highly recommended for any type of partnership that you have a clearly defined operating agreement. This way the roles are defined, and business situations are thought of ahead of time. These situations can be the dissolution of the company, adding an additional partner, or, in worst case scenarios, death. It’s better to have these situations defined ahead of time. The taxation for this structure is once again on your personal returns, split however is defined in the operating agreement. A general partnership is registered with your state government. A DBA may be required by your state to conduct business.
Structure Your Business: Limited Liability Company
The limited liability company (LLC) is a significant step up to the two prior structures. Introduced in the late 1980s, this structure provided the coverage that formerly was reserved for corporations. This structure created limited liability for its owners, unlike the unlimited liability as previous stated. It also provides easy formation, much like a general partnership. And, the structure can have a flow through taxation that allows the taxation to be placed on the owners’ personal return. The protection alone, however, is the reason it is recommended that new companies go at least this route.
Keep in mind, many states charge an annual fee to maintain a LLC. For example, an LLC in California costs a minimum of $600 per year just to have the LLC. Keep that in mind when you do your financial analysis. Additionally, there are some types of companies that you’re allowed to form a Limited Liability Partnership (LLP). This includes professions like lawyers. There are various reasons to pursue that structure if you qualify, but for most companies, an LLC works best.
Structure Your Business: Corporation
The last structure I want to talk about is a corporation. What sets this apart from others, except and LLC depending on the structure, is that corporations are treated as a legal “person” or entity. Because of this, the owners of the company have no personal liabilities to the companies finance. They can never lose more than the amount invested. There are two types of corporations, the C Corporation and S Corporation. The primary difference is taxation. A C Corporation pays taxes on its income and pays dividends to the investors/owners. An S Corporation passes the taxation down to the owners. Unfortunately, the dividends paid by the C Corporation is taxed on the owners tax return, meaning double taxation. So, that’s a negative. Also, it requires a lot of paperwork to create and maintain a corporation, so it is definitely not for the little guy.
Conclusion
The business structure you choose helps build the framework for how you want to operate. Changing structures can add expenses, both time and money, that can be unnecessary and avoidable. Think of the legal ramifications of starting with a sole proprietorship or general partnership before diving in. An LLC can be a great to get personal protection, but may come with additional costs that can affect your bottom line. Next step is to move forward to starting a business.
Disclaimer
Once again, I am not a financial advisor. These tips are some things I have validated with my own personal experiences. If you feel you need more personal advice, please consult a professional financial advisor. Dont forget to check out the Book List for published authors on this topic!
