Which Legal Structure Is Right for Your Business?

Listen in! Pick up some expert advice to a reader's question that we selected from CyberSchmooz.

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:

Legal protection. How important is it to keep your personal and business assets separate? Will you face any liability issues in this business? If liability and legal protection are top concerns, sole proprietorships and partnerships aren’t practical options. You’ll need an LLC or a corporation to protect yourself.
Funding and scalability. If you’re thinking of starting a business that has the potential to scale to a national or international level, or if you’re looking for an easier way to get capital funding, a corporation is probably the right bet for you. If you’re looking to start a business on a smaller scale, an LLC may be better.
Ease of startup. Some business structures are easier to start than others. Corporations tend to be the most complex, requiring a ton of paperwork – and adherence to many laws and regulations. Sole proprietorships are quick and easy.
Tax needs. What are your tax needs going to be? Corporations often face “double taxation” due to facing taxes at both the corporate and personal level. LLCs grant you more control over how you’re taxed and when.

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.

Small Business Tax Center • Idea Cafe Home • Sign Up • Biz Grant Center • CyberSchmooz •Coffee Talk with Experts • People in Biz Profiles • Starting Your Biz • Biz Planning • Running Your Biz • FREE Trade Publications • Marketing • Financing Your Biz • Human Resources • Legal & Biz Forms • Managing Your Biz • eCommerce • You and Your Biz • Gen X • Work@Home • The Fridge • De-Stress • Send an Award • Send an eGreeting • Yoga @ Your Desk • Web Guide • Idea Cafe in the News • About Idea Cafe • Advertise on Idea Cafe • Contact Us • Privacy Policy • Site Map • Small Biz News

DISCLAIMER: We hope whatever you find on this site is helpful, but be cautioned that it may not apply to your own situation, or be totally current at any given time. Idea Cafe Inc. and all of its current and past experts, sponsors, advertisers, agents, contractors and advisors disclaim all warranties with regard to anything found anywhere on this family of websites, quoted from, or sent from Idea Cafe. and its related sites, publications and companies. We also take no responsibility for comments published by others on these pages.

TRADEMARKS: The following are Registered Trademarks or Servicemarks of DevStart, Inc.: Idea Cafe®, Online Coffee Break®, The Small Business Gathering Place®, Take out Info®, Biz Bar & Grill®, Complaint-O-Meter®, A Fun Approach to Serious Business™, CyberSchmooz™, and BizCafe™.