Maybe you’ve got a killer business idea and a bullet-proof business plan, or maybe you’re already raking in some cash, either full-time or on the side. If you’re an entrepreneur, eventually you’ll need to decide how to structure your business.
The three most common kinds of business structures are incorporations, limited liability companies (LLC), and sole proprietorships. Each has distinct pros and cons.
New businesses can choose to incorporate as either a C corporation or an S corporation. What’s the key difference? C corporations face double taxation, meaning the business is first taxed on its profits, and the shareholders are taxed again on their distributions. S corporations are not subject to double taxation, but cannot offer incentive stock option plans.
Advantages of incorporations:
- Corporations can go public, making them attractive to venture capitalists.
- S corporations avoid double taxation.
Disadvantages of incorporations:
- C corporations face double taxation.
- S corporations can only have a maximum of 35 shareholders.
- Both types of corporations require lots of paperwork. They must file articles of incorporation, hold directors’ and shareholders’ meetings, keep corporate minutes, and hold shareholder votes on major corporate decisions.
The LLC is a business structure that has only been around for about 25 years, but is steadily becoming the most popular way to structure a business.
Advantages of LLCs:
- As with corporations, owners are protected from personal liability for business debts.
- LLCs do not face double taxation.
- Earnings and losses “pass through” to owners, meaning they are reflected on owners’ personal income tax returns.
- LLCs have fewer paperwork requirements.
Disadvantages of LLCs:
- Taxation of LLCs varies by state, which is especially a concern if you will do business in several states.
- An LLC can’t go public, which may turn some investors away.
- Lawyers may charge more to form an LLC than a corporation.
- Some states require two or more partners to form an LLC.
A sole proprietorship exists when one person is in business for him or herself.
Advantages of sole proprietorships:
- There is no paperwork to file and no legal formalities in making business changes.
- Taxes are simple, what the business earns or loses, the owner earns or loses.
Disadvantages of sole proprietorships:
- Owner is personally liable for any business debts.
- There is no way to apportion shares of the business, making it difficult to raise capital.
When should you incorporate or form an LLC?
In general, there is no rush to incorporate or form an LLC—even if your business is already operational and making money—unless your business reaches one of these junctures:
- You borrow money for the business.
- You take on one or more business partners.
- You hire employees.
For start-ups, business structures are mostly about liability. Whenever your business reaches a point where you think it could possibly be sued, it’s probably time to incorporate or form an LLC.
What does it take to incorporate or form an LLC?
Incorporating or forming an LLC is a matter of filing the right papers with your state government and paying applicable fees, which range from around $200 to $1,000. The more complex your business, (the more partners you have, or the more money that is invested), the more work will be involved in forming your business entity. That’s when you’ll want to get a lawyer involved.
Otherwise, you can navigate yourself through the process with materials from NoLo, or form your business entity online using a service like LegalZoom. A good gut-check though: If you’re not serious enough to hire a lawyer, you probably don’t need to form a business entity yet.