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Expert Answers to Biz Questions Listen in! Pick up some expert advice to a reader's question that we selected from CyberSchmooz.
Which Legal Structure Is Right for Your Business?
When starting a business, you’ll need to decide how you want to structure it. The legal structure of your business will affect the way it operates, the taxes you pay, your legal protections, and even your course for creating the business in the first place. In other words, the structure you choose for your business will have a massive impact on its eventual success (or lack thereof). So how are you supposed to choose the right structure? Let’s take a look at the pros and cons of each structure, then evaluate your needs. Sole Proprietorships We’ll start with sole proprietorships. These are by far the easiest business structure to start, since you won’t need to set up a separate legal structure. You can operate under your own name. In a sole proprietorship, you’ll pay taxes on any income you make as personal income; there are no special tax rules to learn. However, you’ll be the sole person liable for any legal or financial issues that arise. Pros: Very easy to start, simple to manage, approachable even for a novice business owner. Cons: No liability protection, no ability to scale, little taxation control. Partnerships Partnerships work mostly the same as sole proprietorships, with one major difference: they require two or more people working together. You’ll create an operating agreement together, split the work and the profits as outlined, and ultimately pay taxes at the personal level. Pros: Still easy to start, simple to manage, accommodating for two or more people who want to start a business together. Cons: No liability protection, no ability to scale, little taxation control. LLCs Limited liability companies (LLCs) are slightly more complex, but they offer several advantages over sole proprietorships and partnerships. To start, they’re slightly more difficult to set up; you’ll need to register your LLC in a specific state (and different states have different LLC laws) and get a federal tax ID number. However, if you follow a good guide to starting an LLC, you shouldn’t have any trouble getting through the steps. LLCs are treated as a separate legal entity. Accordingly, they afford their owners some degree of liability protection, and they can take on loans, debts, and assets of their own. They’re also treated as “pass-through” entities, meaning they face no direct taxes on income, but owners and employees must pay taxes on the income they get through the business. Pros: Liability protection, better financial controls, control over taxation, still relatively simple to start. Cons: Harder to start than a sole proprietorship, state laws vary. Corporations Finally, there are corporations. Corporations are treated as separate legal entities like LLCs, and they benefit from the same advantages. However, corporations can also raise funds by issuing public shares of the company. All corporations must comply with a strict list of laws, rules, and regulations, and their corporate income is taxed – resulting in “double taxation” for stakeholders. Pros: Liability protection, ability to raise funds, practically unlimited scalability. Cons: Much harder to start, many rules and restrictions to follow, double taxation on income. Choosing Your Top Priorities Clearly, each business structure has advantages and disadvantages. So how can you choose the “right” structure? Everything boils down to your priorities. What’s most important in your business? Consider:
It can be hard to choose the right structure for your business, especially if you’re a new entrepreneur. But while it’s always possible to change the structure of your business later on, it’s important to make the right choice early. Do your research, talk to other like-minded entrepreneurs, and make the choice that best aligns with your business goals and priorities.
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