Today is Day Three of my Business Start-up Steps posts. Yesterday, I wrote about the second step - finding a business location.
You can start a business without choosing a legal type...technically. In this case, you would be a sole proprietor. But every form you fill out, for taxes or otherwise, requires you to state your business type, so you might as well sit down and think about it and select the type that works best for you.
The Decision Isn't Forever
I should mention that you can always change your legal type. It's easier to go from a simple type, like a sole proprietorship or partnership to a more complicated type, like a corporation, but it's just a matter of paperwork and notifications, and, yes, money to an attorney. So if the type you choose now isn't working for you, or your situation changes, you can always select another legal type.
Criteria For Selection
Here are some questions to ask yourself as you consider what legal type of business to start:
How much time and money does it take to set up? The costs range from minimal, for a sole proprietorship, to expensive, for a corporation. While you certainly want to save money, this cost should not be your primary consideration. Look more carefully at the other questions.
What happens to the business if I am no longer there? If you want the business to continue if something happens to you, form a corporation, or put provisions in your partnership agreement or LLC operating agreement to allow the business to continue without you. If you choose a sole proprietorship, the business ends if you leave or die or can no longer run the business.
How much control do I have? Select a sole proprietorship or single-member LLC if you want complete control. In a partnership or multi-member LLC, you will have to share control with your partners or the other Members. In a corporation, you will have a Board of Directors helping you make decisions, so if total control over the business is important to you, don't incorporate.
Who receives the profits and the losses? If you want all the profits, you must assume all the losses. Set up as a sole proprietorship or an LLC to keep all the profits (after taxes, of course!). If you set up as a corporation, you will have to give some money to the other shareholders in the form of dividends.
Who pays the taxes? In a corporation, the business pays the income taxes, at the corporate tax rate. In most other forms, you can decide to pay taxes through your personal tax return, depending on your personal tax rate.
What is my liability? If you are a sole proprietor, you will have all of the business liability for bad debts of the business, as well as for other liabilities, such as for negligence, product liability, or professional liability. You can limit your liability by setting up an LLC or, even better, by forming a corporation. Because a corporation is a separate entity, you MAY (capital letters here)be shielded personally from the liability of the corporation. This is a tricky area, so make sure you understand your personal liability in each of these forms of business and your liability if you personally guarantee business loans. Find out more from your attorney before you make a decision.
In the end, whatever factors are most important to you will determine the form of business ownership you choose. Talk to your CPA and your attorney for more advice and information.
For more information, read about start-up for the different business types:
Start as a Sole Proprietor
Start as a Limited Liability Company
Start as a Partnership
Start a Corporation (including S Corporation)