Navigating the Complexities of Business Legal Structures
Posted at 1:42 PM - Sunday, April 27, 2008 by Joseph - 0 comments
If I'm going to start a business, I need to go all the way. I need to actually create a legal business, not just run a lemonade stand on the sidewalk. The types of businesses I have to choose from are sole proprietorship, partnership, limited liability company, C corporation, and S corporation. Most of these types of business structures aren't what I'm looking for so I'll just cover them briefly.
The main things to think about when picking out your legal structure are initial fees, personal liability, ability to raise capitol, simplicity to set up, and taxation. Each of these things will be important factors and can change the profitability of your business significantly.
Sole Proprietorship: This is the simplest of the business structures. All that needs to be done is register a fake name form with your local county and publish the new name in a newspaper ad for 3 weeks. Taxation is also quite simple. All business profits simply count as income for the owner. This is just entered on a standard 1040 tax form. Nothing complicated. The draw back is that the business is not a separate legal entity from the owner. They are one. If the business has a debt, the owner has a debt. If the business gets sued, the owner can lose more than just the business. The owner could lose everything just the same as if he were personally sued.
Partnership: This is the same as a sole proprietorship except that two business partners own the business. An important note about partnerships is that either partner can enter into business contracts that both partners are liable for. Think long and hard about who your partner is before entering into this relationship.
Limited Liability Company (LLC): The limited liability company is the new kid on the block, but becoming quite popular. It offers the ease of taxation (if so desired) of a sole proprietorship with the protection of being a separate legal entity. If your business were to be sued, you could only lose as much as you had put into the business. You will have to treat the business as a seperate entity though. It must have its own bank accounts and you must keep very careful records. Owners are known as members. An LLC can be either member managed or manager managed.
C Corporation: A C corporation is your old school, tried and true form of business structure. Owners are known as shareholders and there can be as many shareholders as you desire. Setting up a corporation is quite tricky so you will probably need the help of a lawyer. The biggest down side to a C corporation is that profits are taxed twice. They are taxed once when the corporation itself gets them and then again when the profits are passed on to the shareholders. There is a lot of paperwork to go with a corporation. Quarterly reports will need to be made and minutes for all meetings with directors and the board will need to be kept.
S Corporation: A S corporation is a twist on the C corporation. There is no double taxation. The profits just get taxed once when they are filtered to the shareholders tax returns. The catch is that there can only be up to 75 shareholders. Everything else is just like a C corporation.
With all of this figured out, the question is "What should I pick?" When looking at complexity and the fact that for the time being I will be the sole owner, the choice gets narrowed down to sole proprietorship and LLC. To initially set of a sole proprietorship in IL it costs $5 to file a certificate of ownership of business and then around $100 to print the name for three weeks in a newspaper of general circulation. It will cost $500 to set up an LLC. While the legal protection a LLC would provide me would be nice, I will be running a web based software service. There will be no products shipped to anyone. I'm considering making the software ad supported so the users won't even be paying to use the software. This makes it highly unlikely that I would need the legal protection of a LLC. My plan is to start as a sole proprietorship because the cost is lower and the paperwork is simpler. I'm trying to start this business with very, very little money so saving $400 is a huge deal to me. If the business starts becoming profitable, I will use the earnings from the business to convert to an LLC. In the beginning of my company, I will need to spend most of my time creating a good software product, not on legal paperwork. As my business grows, I can spend more time on legal matters.
Partnership: This is the same as a sole proprietorship except that two business partners own the business. An important note about partnerships is that either partner can enter into business contracts that both partners are liable for. Think long and hard about who your partner is before entering into this relationship.
Limited Liability Company (LLC): The limited liability company is the new kid on the block, but becoming quite popular. It offers the ease of taxation (if so desired) of a sole proprietorship with the protection of being a separate legal entity. If your business were to be sued, you could only lose as much as you had put into the business. You will have to treat the business as a seperate entity though. It must have its own bank accounts and you must keep very careful records. Owners are known as members. An LLC can be either member managed or manager managed.
C Corporation: A C corporation is your old school, tried and true form of business structure. Owners are known as shareholders and there can be as many shareholders as you desire. Setting up a corporation is quite tricky so you will probably need the help of a lawyer. The biggest down side to a C corporation is that profits are taxed twice. They are taxed once when the corporation itself gets them and then again when the profits are passed on to the shareholders. There is a lot of paperwork to go with a corporation. Quarterly reports will need to be made and minutes for all meetings with directors and the board will need to be kept.
S Corporation: A S corporation is a twist on the C corporation. There is no double taxation. The profits just get taxed once when they are filtered to the shareholders tax returns. The catch is that there can only be up to 75 shareholders. Everything else is just like a C corporation.
With all of this figured out, the question is "What should I pick?" When looking at complexity and the fact that for the time being I will be the sole owner, the choice gets narrowed down to sole proprietorship and LLC. To initially set of a sole proprietorship in IL it costs $5 to file a certificate of ownership of business and then around $100 to print the name for three weeks in a newspaper of general circulation. It will cost $500 to set up an LLC. While the legal protection a LLC would provide me would be nice, I will be running a web based software service. There will be no products shipped to anyone. I'm considering making the software ad supported so the users won't even be paying to use the software. This makes it highly unlikely that I would need the legal protection of a LLC. My plan is to start as a sole proprietorship because the cost is lower and the paperwork is simpler. I'm trying to start this business with very, very little money so saving $400 is a huge deal to me. If the business starts becoming profitable, I will use the earnings from the business to convert to an LLC. In the beginning of my company, I will need to spend most of my time creating a good software product, not on legal paperwork. As my business grows, I can spend more time on legal matters.