Figuring out the appropriate legal structure for a small business can be a daunting task, especially considering that each type of structure has trade-offs.
It's crucial to take your time and choose wisely because the structure you select will affect everything from paying to taxes to assigning liability, from raising capital to sharing profits.
Here are the three most common legal structures for businesses -- along with their major pros and cons:
- Sole proprietorship. Of all legal structures, sole proprietorships are the cheapest and simplest. Taxes under a sole proprietorship are straightforward because you don't need to file taxes for your business separately. Instead, you just report all of your business income and losses on your personal income tax return. But sole proprietors also lack many of the legal and financial protections of other business forms. For example, owners are personally liable for any business-related expenses or liabilities and generally still have to comply with local registration and licensing laws.
- Partnership. In a partnership, two or more people co-own a business, and share in the profits and losses of the business. Each person contributes something to the business -- such as ideas, money, or property -- though management rights and personal liability will vary depending on which of three modern partnership forms the business takes: general partnership, limited partnership, or limited liability partnership (LLP). To clarify and prevent partnership issues -- including liability, transferability, and authority -- drafting a partnership agreement is essential.
- Corporation. A corporation is an independent legal entity owned by shareholders and has its own pros and cons. The incorporation process can be expensive, time-consuming and complicated. Corporations also face a slew of administrative, tax, and legal requirements. But on the upside, they limit shareholders' liability and have an established power structure, making it much easier to raise capital and attract investors. There are three major types of corporations: S corporations, C corporations, and limited liability corporations (LLC); each comes with its own caveats.
Which structure is best for your particular business? After you educate yourself by clicking on the links above, that's a question you and your business lawyer will need to hash out together.
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