How to Choose the Best Business Structure for Your Goals
When starting a business, one of the most important early decisions you’ll make is choosing a business structure.
This decision impacts everything from your legal liability exposure to how profits and losses flow through to your personal tax return.
With so many options like sole proprietorships, partnerships, LLCs, and corporations, how do you select the right model for your goals and risk tolerance? Our business startup lawyer shares insights.
Key Decision Factors – Risk and Control
Ultimately, choosing a business structure involves balancing risk against control. Sole proprietors and general partnerships offer complete managerial freedom and flexibility but also unrestrained personal liability. You retain full control, but your personal assets get tied up in the business’s fate.
Alternatives like corporations and LLCs create boundaries between business and personal finances, limiting legal liability for the company’s debts and obligations. But with greater protections come more rigid governance requirements and financial reporting rules.
Before evaluating specific structures, prioritize what matters most:
- Safeguarding personal assets from business legal or debt liabilities?
- Retaining maximum control over operations and profits?
- Lowering overall tax burdens on profits?
Once you rank priorities, weighing options gets much easier. Now, let’s examine the key pros and cons of common structures.
Analyzing The Major Business Entity Types
Determining what type of business entity is best suited for your new venture can have significant impacts down the road. The business structure you choose will affect personal liability, taxation, record-keeping, and more.
Here are the most common types of business entities.
The simplest and most common “structure” is a sole proprietorship – an unincorporated business owned and operated by an individual. Many entrepreneurs intuitively start this way, perhaps by providing freelance services or running a small online shop.
Filing requirements are minimal compared to other entities, making proprietorships quick and inexpensive to establish. You simply need requisite local business licenses related to your operations. Income and expense flow through to your personal tax return without any “corporate veil.”
This flexibility comes at the price of unlimited personal liability. Any debts or legal actions taken against the business expose your house, cars, investment accounts – your entire net worth. It is rarely ideal as operations grow, credit lines expand, and contractual risks multiply.
Partnership (General or Limited)
Forming a partnership allows two or more people to combine skills, investment dollars, or other resources under a shared venture. Partners split responsibility for managing the business while also dividing profits.
In a general partnership, all partners have equal standing legally and financially. Each can enter into binding contracts or take on debts on behalf of the overall business. Yet poor decisions by one partner still create a joint liability risk for everyone. Being held accountable for the mistakes of others rarely sits well.
For limiting liability exposure among partners, a limited partnership (LP) offers a more appealing alternative. Here, “general partners” handle daily operations and carry greater personal liability, similar to a proprietorship or general partnership.
But “limited partners” have smaller capital investments tied to the company with less control, but are shielded from direct legal actions or losses beyond their invested dollars.
Limited Liability Company (LLC)
Over the last few decades, LLCs have surged in popularity thanks to a compelling blend of liability protections, tax efficiencies, and flexibility.
LLCs legally separate the company from owners’ personal finances, limiting liability similar to a corporation. Yet they deliver these safeguards without onerous paperwork burdens that incorporate companies face in California. They also avoid the double taxation problem with C-Corps since income flows through to owners’ tax returns.
Compared to sole proprietorships, LLCs better shield assets like your house from frivolous lawsuits, contract disputes, or an employee’s negligence. They also allow for unique member/manager structures, where centralized authority isn’t fully distributed across members who share ownership. Overall, the simplicity yet protections make LLCs a versatile option for lean startups poised for growth.
For venture capital-backed startups intent on eventually going public, C-Corporations remain the standard. “C-Corps” creates the strongest separation between a business and owners’ personal liability due to rigorous governance rules. Shareholders, directors, and officers gain legal protection from company debts and court judgments.
But with such formidable defenses come costs in effort and taxes. Significant paperwork and protocols must be maintained to preserve corporate integrity, from stock transaction logs to annual filings. Owners also endure “double taxation” since company profits get taxed at the corporate level, then taxed again as personal income when distributed to shareholders via dividends.
For cash-strapped early-stage businesses, such burdens rarely make sense compared to LLCs. But C-Corps remains the expected model for eventually accessing public markets.
A newer business structure gaining popularity is the B-Corporation, or “B-Corp.” B-Corps aim to use the power of business to solve social and environmental problems. They legally embed standards around sustainability, ethical practices, employee treatment, and social impact into their charter documents.
B-Corp status, attained through certification by the non-profit B Lab, enables mission-driven companies to consider community stakeholders, not just shareholders. They otherwise provide similar limited liabilities to owners as LLCs and C-Corps do. Prominent certified B-Corps include Patagonia, Ben & Jerry’s, and Kickstarter.
S-Corporations are a special election made with the IRS to obtain pass-through tax efficiencies of partnerships without sacrificing limited liability protections. Owners pay taxes on their proportionate business income on personal returns, avoiding “double tax” issues.
S-Corps also impose stricter ownership rules, requiring all shareholders to be U.S. citizens or residents. Formerly reserved for small organizations, size caps were lifted in the 1990s.
Which Option Aligns with Your Goals?
Rather than default to norms, choose a structure tailored to your objectives. Weigh priorities around taxation, liability limitations, and governance flexibility before committing.
The legal requirements are different for a company raising money from angel investors or venture funds compared to a small family-owned business. An entrepreneur who wants to sell the business soon may choose a different legal structure compared to founders who plan to stay in business long-term.
Context matters – structure follows strategy. Meet with business law attorneys to map best-fit options for your goals. Think through bi-directional transitions too. If an LLC no longer suffices after five years of growth, migrating to a C-Corp or S-Corp should be fairly straightforward, with proper planning upfront.
Choose wisely at the outset, but don’t box yourself into a single model forever. As your business grows, periodically reevaluate if your structure still aligns with evolving priorities. An entity that once served you well could eventually hold you back.
Contact TONG LAW to Explore the Right Fit
We hope this overview helps provide perspective on key factors driving entity choice and dispels misconceptions around business formalities. Formation seems daunting but gets much simpler when you focus on impacts around liability, taxation, investor needs, and long-term aspirations.
For a personalized discussion on the ideal structure for your current business activities and future goals, reach out to TONG LAW.
Our business formation attorneys at TONG LAW have guided clients across industries through entity formation and transitions for years. We know the impacts of different models intimately and will suggest the best fit based on your unique situation. Contact us now for a consultation.