Deciding on a business structure can seem like an overwhelming task. Here are some steps that can help you settle on the best one for your business.
Establish a Business Plan
The first step you should take in deciding on a business structure is to develop a business plan. This does not need to be something you are going to present to others, but it will be a useful tool as you get started.
Include how you plan to finance your business. That can have a big impact on the structure you ultimately choose. Some businesses have options to sell stock to raise capital, while others get special tax considerations.
Do you plan to grow this business beyond a small or mid-sized company? If so, your structure should be flexible enough to allow for that growth.
How much risk does this business pose to you, both legally and financially? Some business structures can help limit your personal liability in the case of lawsuits or business failure.
Paperwork and filing requirements vary between business structures. Be sure to understand exactly what is required for each one and what you are comfortable doing. In most cases, you will need to keep personal and business finances completely separate for reporting.
Examine Possible Structures
You will have several options to consider when deciding how to structure your business. Each has advantages, disadvantages, and requirements that may make it a hit or miss for your business. In some cases, structures can be combined to create hybrid entities. Here are the most common ones.
A sole proprietorship is the most basic business structure possible. It is for a single business owner and does not differentiate between you and the business financially or legally. This will require the least amount of paperwork, and can generally be formed quickly, easily, and relatively inexpensively. You also retain complete control over business decisions. However, a sole proprietorship offers owners no legal or financial protections.
Much like a sole proprietorship, a partnership is a simple business structure, but this one has two or more individuals working together. They can be set up so that one person absorbs most of the risks associated with running the business or it is evenly distributed. Taxes are filed through personal returns.
While there are many different tax situations that can affect reporting and requirements, all corporations start off as C Corps. This is the basic corporate business structure, and it can be a good fit for medium or large businesses, or those looking to expand in the future.
If you are planning a small business, applying for the IRS-designated S Corp status is a popular choice. This offers all of the liability protection of a C Corp, but it also allows owners to file their corporate taxes through their own personal returns. This helps eliminate the double taxation that can occur in a traditional corporation. Setting up an S Corp is a two-step process where you will file to register your business with the Secretary of State and then apply for the S designation from the IRS.
If you are planning to operate your business for the benefit of the public, then you might consider applying to become a nonprofit corporation. In general, you must file to operate a nonprofit in your state and then request a tax exemption from the IRS.
This designation may allow you to raise funds by offering tax deductions to donors. It can also help you avoid income taxes on business profits. However, any profits must be reinvested back into the business and cannot be distributed to shareholders.
If you aren't looking to issue stock but would like to limit risk, then a Limited Liability Company (LLC) may be the way to go. This structure allows one or more owners to limit their financial and legal risk, yet maintains some of the simplicity of a partnership arrangement. Taxes are filed through personal returns but finances are kept separate. Owners are responsible for self-employment taxes on any business income.
Understand Your Business Personality
You will need to establish and understand your business personality to make an informed choice. Your risk tolerance, financial position, and the amount of paperwork you are comfortable with will all be factors in how you set up your company. Ultimately, you will need to decide on a structure that balances your business personality with its goals.