If you are thinking about launching your business, you need to familiarize yourself with the different legal structures you can adopt. This is one of the first steps you should take towards the creation of your business since you will need to follow a slightly different procedure to establish your company as a legal entity depending on the structure you choose.
Why Do You Need To Choose A Legal Structure?
Businesses are considered legal entities. Once your business is established, this entity will be able to borrow money, obtain funding from investors, and be owed money to by creditors.
In order to exist as a legal entity, you need to pick a legal structure for your business. The legal structure you select will determine who is liable for the debt of the business, and how taxes are filed.
Did you know that almost three-quarters of businesses are sole proprietorships? This legal structure is adapted to the needs of a wide range of business owners and requires a minimal amount of paperwork.
If you are looking for a sole proprietorship definition, think of this structure as the typical small business owned and operated by a single person. You shouldn’t use this structure if you plan on having partners.
From a legal point of view, you and your business are the same entity. Here are the advantages of this approach:
- You can easily create a sole proprietorship with little paperwork.
- The original filing fee is low.
- You can dissolve your business whenever you want.
- The profits and losses of the business are considered as your profits and losses. This makes filing taxes easier since you would claim these profits and losses on Schedule SE and Schedule C.
The main downside of registering your business as a sole proprietorship is that you will be personally liable for your business’ debt. There are no legal distinctions between the business’ assets and your assets.
This means your assets could be seized to pay back a business debt, even if you dissolved the sole proprietorship.
Raising capital for a sole proprietorship can be challenging since you will only be able to use your assets as collateral. This structure would still be a good option for a small business that doesn’t need a lot of starting capital.
If you are launching a business with the help of a partner, you won’t be able to register it as a sole proprietorship. The best business legal structure for a partnership depends on the roles each partner will play.
You should take some time to assess what each partner will bring to the business, which role they will play in daily operations, and what kind of liability they will have. You should define the terms of your partnership in a written agreement signed by all the partners regardless of the legal structure you choose.
Your written agreement should go over what each partner will bring to the business and what their role and responsibilities will be. The agreement should also specify how profits will be shared, how disputes will be resolved, and in which situations the partnership would be terminated.
In this scenario, there are two or more partners who share profits equally. The partners have the same amount of control over the business and everyone is liable for the business debt.
Just like with a sole proprietorship, personal assets can be seized if the business debt isn’t paid off. It is possible for creditors to collect a debt from a single partner. This individual would then be able to sue the other partners.
Profits and losses are claimed on each partner’s individual income tax return, and each partner is required to act in the best interest of the business. If this isn’t the case, the partnership can be dissolved.
The downside of this business legal structure is that each partner can legally represent the business. A partner could sign a contract or apply for financing without the input of the other partners.
Qualified Joint Venture
This is a legal structure created for small businesses owned by couples. If you want to start a business with your spouse, this will probably be the option that makes the most sense for you.
Both spouses are involved in the business’ operations and there is a partnership agreement that defines how profits and liability are shared between the spouses.
The advantage of a qualified joint venture is that you can file your taxes as a sole proprietorship and each spouse would file Schedule SE and Schedule C to report profits and losses.
This is the business legal structure you would choose if you want to have a mix of general partners and limited partners. Limited partners typically contribute to the business’ financing but aren’t involved in the operations.
The purpose of forming a limited partnership is to secure financing from investors without making them liable for the business’ debts.
This structure is similar to a general partnership, but it is limited to a single project. This is the structure you would choose if you wanted to develop a product with another business without becoming partners for other aspects of your operations.
You and your partners would need to determine how profits, losses, and liabilities are shared for this project. From a legal point of view, a joint venture becomes a separate business entity, and each partner owns a certain percentage of this entity.
Limited Liability Company
The LLC meaning is Limited Liability Company. This business legal structure limits your liability when it comes to repaying the business’ debt.
With this structure, the business becomes a separate legal entity. The business’ assets and debt are distinct from your assets and liabilities.
Creating an LLC is fairly easy and inexpensive. You will have to report the company’s profits and losses on your tax return.
If you look for an LLC definition, you will find that this structure includes businesses with a single owner and partnerships. If you want to register a partnership as an LLC, you will need to write articles of organization and an LLC operation agreement that states what each partner role will be and how profits will be shared.
A corporation is a more complex structure that is typically used for larger companies. It exists as a separate legal entity and is subject to corporate laws and tax requirements.
A corporation is owned and operated by a group of shareholders. The advantage of this legal structure is that the business itself is liable for its debt.
This is the only business structure that is allowed to issue stocks. There are higher costs associated with forming a corporation. However, this is an option you should consider if your goal is to eventually raise capital with stocks.
You can register a business as a C corporation or as an S corporation. With a C corporation, the business would have to pay corporate taxes and shareholders will then need to pay an income tax.
You can create an S corporation if your business meets a few requirements, such as having fewer than 35 shareholders. With an S corporation, the business doesn’t pay a corporate tax but shareholders have to pay an income tax.
How To Register Your Business As A Legal Entity
There are a few legal steps you will need to take to register your business as a legal entity. However, some legal structures don’t require you to register your business as a legal entity with your state.
You don’t need to register your business to exist as a sole proprietorship. However, there might be local ordinances that require you to register your sole proprietorship with your city.
You will need to register your business name by filing a DBA (Doing Business As) form with your state. You should apply for an EIN (Employer Identification Number) with the IRS only if you plan on hiring staff. Depending on the industry you are in, you might need to apply for professional licenses or permits, for instance, if you will be handling food or providing a health-related service.
If you opt for another business structure, you will need to file articles of incorporation with your state and pay a filing fee. Visit your Secretary of State website to download these forms. You can also find out more about the requirements you will need to meet to register your business in the website. You will then be able to file a DBA, apply for an EIN, and apply for any relevant professional licenses or permits.
These are the main business legal structures. Even though a majority of businesses are created as sole proprietorships, you might find that another structure makes more sense for you. Ask yourself how you would like to report profits and losses, how much liability you are comfortable with, and whether or not you will have a partner to select the most relevant legal structure.