Choosing a Legal Structure For Your Business
Before you can start making money off of your idea, you’ll need to decide a legal structure for your business. There are four main legal structures for small businesses in the United States: sole proprietorship, partnership, corporation, and limited liability company. Each structure has different tax implications, liability, flexibility, legal records, and costs.
Sole Proprietorship
Many businesses begin as sole proprietorships and remain that way throughout the life of the business. Others begin this way, and switch to a more complicated legal structure as they experience growth. You don’t need to file any special paperwork or pay for licenses as a sole proprietorship, and bookkeeping and taxes are generally fairly simple. Sole proprietorship might be a good route if you intend for your business to remain small, or you don’t feel like the hassle of filing legal paperwork is necessary for your business at this time. While the sole proprietorship has the upside of simplicity, it also has the downside of having unlimited liability, meaning that the owner is personally responsible for any losses or lawsuits the business might experience.
Partnership
A partnership is the next simplest form of legal business arrangement. In a partnership, two people come together to incorporate a business. A partnership agreement outlines each partner’s responsibilities in the company. Having a partnership can make it easier to acquire capital, since both partners' resources can be tapped; it can also be less stressful to share management duties of the business. Partnerships also have unlimited legal liability for both partners.
Corporation
It may make sense for your business to form a corporation. Corporations, unlike partnerships or sole proprietorships, are treated like separate legal entities; their equity continues, even if managers involved in the corporation leave. Corporations also have limited legal liability. A downside of becoming a corporation is that it is more expensive to complete the necessary paperwork, and federal and state taxes become much more complicated; corporations are taxes once at the corporate level and once at the shareholder level. Due to the many factors involved in setting up a corporation, it makes sense to consult with an attorney and accountant before going this route.
Limited Liability Company
An LLC can be thought of as a hybrid between a corporation and a partnership. The owners of the LLC have limited legal liability over the actions of the company, and in the eyes of the law it is still a separate legal entity. The owners are responsible for raising the capital to fund the venture, but their personal assets are not at stake should the business suffer massive losses. The taxes for limited liability companies tend to be simpler than for corporations, and are usually treated like taxes for a partnership. A downside of LLCs is that their treatment on state taxes varies from state to state, and their legal costs are higher than for a partnership or sole proprietorship.
Sources:
Starting and Growing Your Small Business. (2010) Virginia Tech Cooperative Extension.