But, at this stage in the game it’s a good idea to develop a solid business plan. Plan to hire an experienced professional to help if necessary. And, now is the time to really consider how to structure the business.
These types of details can seem mundane and maybe even confusing. However, it’s important to take the time to thoughtfully weigh the options so that the company can benefit from the proper structure.
What does the term business structure mean?
A business structure, also known as a business entity, is basically the way in which a company is organized. There are several types of business structures from which to choose. Before becoming familiar with each type, it’s helpful to know why an entrepreneur needs to operate within a business structure in the first place.
Federal tax reporting is one of the main reasons why business structures exist. And, according to entrepreneur.com, there are three main factors that should be considered when choosing a business entity:
• Record Keeping
Entrepreneurs may not be overly familiar with the above three factors when first starting their businesses. However, it’s helpful to realize that the management of these three tasks will be impacted by which business structure is chosen.
Types of Business Structures
The U.S. Small Business Administration (SBA) is a great resource for entrepreneurs and their website lists the five types of business structures:
• Sole Proprietorship
• S Corporation
• Limited Liability Corporation or LLC
Sole proprietorship is likely one of the most common ways to organize a company and is defined as owning an unincorporated business as an individual. An important point to know is that the owner is liable for all of the business’s financial obligations.
A Partnership means that two or more people agree to run the business and that all parties contribute resources as well as share in the profits and/or losses. As far as taxes, the business must report on annual financial operations, but the company does not pay income taxes. The partners take care of income tax considerations via their own personal tax returns.
Corporation or S Corporation is typically a more complex business structure. An entrepreneur would likely need professional advice when starting down the path of forming a corporation. Two important factors stand out. The first is that a corporation becomes its own legal entity that is separate from the founder(s). Secondly, a corporation does offer the potential to avoid personal liability but the large amount record keeping can be difficult to manage.
Limited Liability Company, or LLC, is a popular option. Often thought of as a hybrid between a corporation and a partnership, an LLC structure protects the owners from liability while allowing for some benefits that a corporation may enjoy. Different states can have varied LLC statutes so make sure to research your state’s guidelines when considering an LLC.
How do you choose?
Dana Harness became an entrepreneur several years ago when she started a successful company called Shield Shell. She and her husband also own Harness Design Indy which is a graphic design/web development business. Along the way Harness has learned a lot about selecting a business structure that works.
“We chose to set up LLCs because they offer legal and tax protection for small business owners over a sole proprietorship,” Harness said. “The tax part is much simpler than C-corps or S-corps; the income is reported on our regular tax return and we just file a Schedule C for each business. It’s worked very well for us over the years.”
Things to Consider
Harness brings up good points about tax considerations and reporting. Typically there will be a significant amount of financial reporting requirements for a business that operates as a corporation rather than an LLC.
But, if a business owner believes a company will rapidly evolve into a bigger entity within five to 10 years, it may be worth considering a corporation. This is especially important if an entrepreneur is open to accepting stockholders at some point.
Make it Official
Once a business structure is chosen, the next step is to complete the set up. A business structure is also a legal structure, so it makes sense to consult with a lawyer. Even though an entrepreneur may not have to file official paperwork for a sole proprietorship, some states will require licenses or permits. Paperwork is likely required for all other business types so it cannot be emphasized enough that an entrepreneur should make arrangement to obtain some type of legal counsel.
Starting a new business is exciting. Learn as much as you can through networking. Find other successful entrepreneurs to talk to and ask them how they made the important business structure decision. Did they spend time and money consulting with experts or did they wade through the research themselves and choose an option on their own? Don’t forget that agencies like the SBA offer free business classes/tutorials on their websites.