Congratulations! You’ve launched your business. At this point, you have decided on a business idea, a name for your business and have started mapping out your business strategy. Maybe you already have your first set of sales. Now it’s time to make things official and formalize your business’ legal structure by deciding on which type of business entity best fits your needs. There are many different types of legal structures for businesses, but I am going to focus on the top five types of business entities to consider for your online business, which will apply to the vast majority of you.
1. Limited Liability Company (LLC)
Limited Liability Companies (LLCs) are one of the most common business entities for small businesses because of its versatility. An LLC provides the members (owners) the legal separation and protection of a corporation, while being taxed on profits and losses on the members’ personal income taxes. Here is a breakdown of the pros and cons of an LLC in a more easily dissectible manner.
- Separation & Protection – Members’ personal assets are separated from the business’ assets and losses. Therefore, in the event that your business doesn’t do well or your business is involved in a lawsuit, creditors/lawsuits cannot try to make a claim against personal bank accounts or personal property.
- Tax Benefits – LLCs are taxed via the members’ personal income tax filing, something called “pass-through taxation.” This can be beneficial for many businesses, since the tax rate can be much higher for corporations than for individuals. You also can avoid double taxation, which you would incur with a business structured as a corporation.
- Multiple Owners – LLCs can have many owners and offers the best option for dispersing earnings or managing losses amongst the members.
- Ease and Cost – Registering and making changes to an LLC is easy to do and also inexpensive, sometimes costing around $100 or less, depending on your state.
- Diligence – LLC members must be very diligent in their use of business resources. In the event of litigation, if a member hasn’t clearly demonstrated the separation of business transactions from personal, then personal assets may be at risk.
2. C Corp
C Corporations are the most common type of corporation in the United States. It is an individual entity, meaning the entity itself is separate from its owners. Within a C Corp, an owner is considered to be a shareholder.
- Raising Capital – If you are planning on raising capital for your business, most investors will want your business to be a Corporation so that there are shares to buy and sell.
- Separation & Protection – Similarly to an LLC, the business assets in a C Corp are separated from the owners’ (shareholders’) personal assets.
- Attracting Talent – If you’re a startup trying to attract employees, you likely don’t have a ton of money yet to spend on compensation. A C Corp can help with that by offering stock or stock options.
- Double Taxation – The Corporation pays taxes on its income for the year and the shareholders also pay a tax on the dividends received from the corporation.
- Employer Tax – Corporations pay their half share of their employees’ Social Security and Medicare taxes.
- Ease & Cost – C Corps can be more complicated to register and maintain and are more expensive than most other types of business entities.
- Corporate Meetings – As a corporation, you must hold regular meetings and maintain notes of those meetings.
3. S Corp
An S Corp is a business entity that combines the operating structure of a C Corp, but is taxed similarly to an LLC/Partnership.
- Separation & Protection – As is true with C Corps and LLCs, business assets in an S Corp are separated from personal assets.
- Avoid Double Taxation – Net profits/losses are divvyed up amongst the shareholders (owners), which are then filed on their personal income tax return.
- Limitation of Shareholders – An S Corp can only have up to 100 shareholders, so this may not be attractive to investors.
- Ease & Cost – S Corps are more complicated and expensive to register and maintain than LLCs or Partnerships.
4. Sole Proprietorship
Sole proprietorships are the simplest form of business and make up almost three-quarters of all businesses in the United States.
- Ease & Cost – Sole Proprietorships are the most cost-effective and easy type of business entity to set up and maintain, as there is no state filing procedure required to form them.
- Ownership – The owner is the only person responsible for the business and decision-making, unlike in corporations or LLCs where there may be many shareholders or members.
- Liability – There is no separation between your business assets and liabilities and your personal assets and liabilities. This means if your business goes south, your personal assets may be at risk as well.
- Raising Capital – Most investors will not invest in sole proprietorships.
Partnerships are owned by two or more individuals who share the costs and responsibilities of the business.
- Partnership – Unlike a sole proprietorship, in a partnership there is more than one owner to share the burden of running a business.
- Ease & Cost – Partnerships are very cost effective and easy to start up and maintain.
- Tax Benefits – Taxes are passed through personal income taxes.
- Liability – Similarly to a sole proprietorship, your personal assets and liabilities are not separated from your business assets and liabilities.
- Sharing – You will have to share profits and decision making.
Which Business Structure is Right for Your Business?
Some things to consider when choosing which business entity is best for you:
- How many owners are there?
- Will you have employees?
- Do you plan to raise capital?
- What is your liability comfort level?
- Are you a small business or is your business going to scale?
Based on your type of business, you may already have an idea of which type of entity would be best for you; however, you will want to go a step further to understand the laws and fees for each of these five types of business entities to consider for your online business. Choosing the wrong business legal structure can have serious legal and tax implications, so make sure you contact your local legal or tax professional for advice relating to your specific business.