Since the turn of the 21st century, new entrepreneurs have consistently entered the business foray, with different goals and plans in mind.
Many new businesses fail, but that has not, and should not deter new entrepreneurs from pursuing their ambitions.
Unfortunately, statistics show that a significant number of potential entrepreneurs are deterred from starting new enterprises due to the fear of failure.
Often, the failure of a business venture is rooted in its poor foundations, especially when it comes to business structure formation. The complexity of the legal terrain might be overwhelming for new entrepreneurs, but now that you are reading this, you don’t need to worry.
Whether you plan to start a new business or restructure an existing one, this article will help you understand the implications of your business structure by working you through key aspects of business structure formation.
Types of Business Structures
One of the most important decisions you will ever make when founding a business is choosing a business structure. Doing this successfully lies in understanding the various legal entity types available to you, each with its own sets of characteristics, advantages, and potential drawbacks.
In this section, we will look at the major types of business structures available.
Sole Proprietorship
If you love the idea of being in complete authority over all business decisions, then a sole proprietorship will probably be the best business structure for you. It is the most common structure primarily because it is easy to establish with minimal paperwork.
More so, the business’s profits and losses are reported on the owner’s personal tax return based on their annual income. This simplifies tax filing and a whole lot of other business activities. However, sole proprietorship has a limited ceiling and it is most suited for small businesses.
If you have very ambitious plans to rapidly expand your business, you should be looking towards other options, also because sole proprietorships face challenges in raising capital since there is no stock issuance.
Partnership
When two or more people come together and jointly agree to share ownership of a business, that is a partnership.
There can be different kinds of partnerships, including general and limited partnerships.
A general partnership is not significantly different from a sole proprietorship, besides the fact that more than one person is controlling the business and is personally liable for business debts. Partnerships may even be more complicated due to the potential for disputes.
Some businesses have limited partners who may have some involvement in business administration but don’t assume full management as general partners do. This also means that limited partners have limited liability in terms of debt.
Limited Liability Company (LLC)
Many startups begin as LLCs. An LLC typically combines elements of both a corporation and a partnership. This means that, like a corporation, it provides liability protection, but like a partnership, it offers flexible management structures.
LLCs also have tax flexibility, as they may choose how they want to be taxed, as a sole proprietorship, partnership, or a corporation. This makes the LLC option very attractive to business owners who are trying to play it safe in terms of business structure formation.
Corporation
In sole proprietorships and partnerships, the business is identified with its owners. However, corporations assume a separate legal identity from their owners. The purpose of this is to provide strong liability protection to business owners.
Liability protection makes it easier to raise capital through the issuance of stock. Another advantage of this is perpetual existence, which means that the business continues to exist even if ownership changes.
For all their benefits, corporations can be very complicated. They require adherence to strict regulatory and compliance requirements, including regular board meetings and detailed record-keeping. Moreover, depending on the type of corporation, owners may face double taxation.
Other Considerations for Business Structure Formation
Beyond choosing a business structure, there are also other critical factors you must consider. These are highlighted below to help guide your decision-making:
1. Legal and Tax Implications
From the discussion of the various kinds of business structures, it is clear that each kind offers different legal and tax implications, particularly when it comes to liability protection.
LLCs and corporations are more secure, while sole proprietors and owners of partnerships are more exposed to personal risks if the business incurs debts or faces legal issues.
Therefore, before starting a business, you need to consider the level of risks to your assets that you are comfortable accommodating, as well as tax treatment.
2. Financial Considerations
As you must know, founding a business requires significant financial commitments. In terms of business structure, you need to consider the finances of not just registering the business but also sustaining it.
Sole proprietorships have the lowest cost to start and maintain, but they provide limited funding opportunities. If your product or service requires a huge amount of resources for which you must seek external funding, consider setting up the business as an LLC or a corporation because those offer the best protection to investors.
3. Management and Control
Business structures vary in terms of ownership and management flexibility. Sole proprietorships are highly flexible because the owner has a lot of freedom; however, there are limited expansion opportunities. Sole proprietorships usually remain small businesses.
Partnerships might have complicated management due to multiple owners, but careful agreements on administration and profit-sharing can mitigate disputes.
LLCs generally provide more flexibility in management structure than corporations, which are more rigid.
4. Future Growth and Changes
Choosing a business structure is not a lifetime action. In the course of their lifetime, businesses often require a change in structure due to new goals and directions set by the owners and leaders. However, changing your business structure later can be complex and costly.
Therefore, it is best to start by choosing a structure that will serve your business well into the future based on growth factors such as your need for investment, plans for expansion, succession planning, and so on.
5. Regulatory and Compliance Requirements
While this article seeks to give a broad overview of the requirements for forming a business in 2024, don’t forget that the details of these requirements vary by state. Those details matter a lot and they determine things like what you get to pay in taxes as well as ongoing compliance requirements.
Moreover, depending on the nature of your business and industry, you might need to obtain specific licenses and permits. So, ensure to research all the requirements that apply to your business before setting out.
6. Legal Advice
Starting a business might seem like a straightforward venture, but there is a lot of complexity in the details. As the saying goes, the devil is in the details.
More so, choosing the structure of your business is a decision with long-term implications, not just for the business entity, but for yourself too.
Hence, it is best to consult with a business attorney to help you understand the nitty-gritty of the legal implications of different structures. Other professionals, such as accountants and general business advisors, can also offer valuable insights that will help you make the best decision for the business you have in mind.
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