One of the first decisions an entrepreneur must make is about how best to structure his or her business. It is also arguably one of the most important decisions, as the structure they choose will have legal and tax implications.
A variety of options is available. The following gives brief descriptions of several, one of which may be the one best suited for your business.
A sole proprietorship is the simplest and most common structure chosen to start a business. One person – the “sole proprietor” – owns the business by him or herself and is responsible for its assets and liabilities. As an unincorporated business owned and run by one individual, there is no distinction between the business and the owner. The owner is entitled to all profits and is responsible for all the business’s debts, losses and liabilities.
Partnerships are the simplest structure for two or more people to own a business together.
There are two common kinds of partnerships: limited partnerships (LP) and limited liability partnerships (LLP). Limited partnerships have only one general partner with unlimited liability, and all other partners have limited liability. The partners with limited liability also tend to have limited control over the company, which is documented in a partnership agreement.
LLPs are similar to limited partnerships, but give limited liability to every owner. An LLP protects each partner from debts against the partnership; they won’t be responsible for the actions of other partners.
Partnerships can be a good choice for businesses with multiple owners, professional groups (such as attorneys), and groups who want to test their business idea before forming a more formal business.
Limited Liability Company
A limited liability company (LLC) is designed to provide the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. It enables a business to take advantage of the benefits of both the corporation and partnership business structures.
LLCs protect the owner from personal liability in most instances. Their personal assets — such as vehicles, house and savings accounts — won’t be at risk in case the LLC faces bankruptcy or lawsuits.
The two most common types of corporate structures are the C corp. and the S corp.
A C corp is a legal entity that is separate from its owners. Corporations can make a profit, be taxed and can be held legally liable.
Corporations offer the strongest protection to its owners from personal liability, but the cost to form a corporation is higher than other structures. Corporations also require more extensive record-keeping, operational processes and reporting.
Unlike sole proprietors, partnerships, and LLCs, corporations pay income tax on their profits. In some cases, corporate profits are taxed twice — first, when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns.
An S corporation, sometimes called an S corp, is a special type of corporation designed to avoid the double taxation drawback of regular C corps. S corps allow profits, and some losses, to be passed through directly to owners’ personal income without ever being subject to corporate tax rates.
Not all states tax S corps equally, but most recognize them the same way the federal government does and taxes the shareholders accordingly. Some states tax S corps on profits above a specified limit and other states don’t recognize the S corp election at all, simply treating the business as a C corp.
There are special limits on S corps. S corps can’t have more than 100 shareholders, and all shareholders must be U.S. citizens. S corps still have to follow strict filing and operational processes of a C corp.
Both C corps and S corps have independent lives. If a shareholder leaves the company or sells his or her shares, the corporation can continue doing business relatively undisturbed.
A cooperative is a business or organization owned by and operated for the benefit of those using its services. Profits and earnings generated by the cooperative are distributed among the members, also known as user-owners. Typically, an elected board of directors and officers run the cooperative while regular members have voting power to control the direction of the cooperative. Members can become part of the co-operative by purchasing shares, though the amount of shares they hold does not affect the weight of their vote.
For guidance on choosing the best legal structure for your business, contact the Economic Development Collaborative-Ventura County. Conveniently located in Camarillo, California, we’re here to help!