Got a business idea and wondering which structure suits you best? You’ve come to the right place! There are many different options on how to organize your business, each with their own benefits and pitfalls. Choosing the right one can be tricky, but I’m here to make it easier. With so many options, finding the best fit can feel overwhelming. This guide will help you narrow down your choices and focus on what works best for your needs.
Sole Proprietorship
Sole Proprietorships are extremely easy to form because it does not require any paperwork. Let’s say you bake sourdough loaves a few times a week and sell them at the local farmers market. Congratulations - you have a sole proprietorship. There is some additional forms needed when you file your tax return, but otherwise its very simple. The downsides are that your personal assets are not separate from your business assets. So if you got sued for activities arising from your business, all of your personal assets (house, car, savings) are at risk. If you wanted to get a loan or investors, its also harder with a sole proprietorship because they are essentially giving you the money, trusting you will use it for the business. This is a great option if you want to give your business idea a test run to see its viable, but if it takes off you might want to consider converting to one of the other options.
PRO | CON |
Easy and inexpensive to set up | Unlimited personal liability |
Complete control over the business | Difficulty raising capital |
Simplified tax reporting | The business dies with the owner |
Partnership
Partnerships are the simplest way to go into business with, well, a partner—or several. Unlike a sole proprietorship, partnerships do require some paperwork to form but it is not too time consuming. There are two kinds of partnerships: limited partnerships (LP) and limited liability partnerships (LLP).LPs must have one (and only one) general partner, essentially the 'lead' partner. This partner has unlimited liability, similar to a sole proprietorship. All other partners have limited liability and thus are less at risk if the business fails, but also have limited control over the company. LLPs on the other hand give limited liability to every partner, and each partner is only liable for their mistakes, not their partners. Partnerships are a good option for giving your business a test run, and potentially in the long run if you have a good working relationship with your partners and understand the risks.
PRO | CON |
Easy to establish | Joint liability for general partnerships |
Combined resources and skills | Potential conflicts between partners |
Profits are passed through to partners' personal tax returns | Shared profits |
Limited Liability Company (LLC)
If you’ve tested the waters and your business is gaining traction, it might be time to get serious with an LLC. It does take some paperwork to form, but in California you can do it all from your phone in about 15 minutes. This structure gives your personal assets protection as they are distinctly separate from your business. In most cases, these are considered pass-through taxation entities, which means that your business does not get taxed on its profits. Instead, the profits are reported as income on your individual tax return, and you pay taxes there. However, you are considered self-employed and thus subject to self-employment taxes. Check out our article "Freelancing - Is It Really Better?" for a deep dive into self-employment taxes and the added administrative burdens. If you want personal liability protection at the cost of some fees and administrative work, an LLC might be a good option for you.
PRO | CON |
Limited personal liability | More complex and expensive to establish than sole proprietorships and partnerships |
Flexible management structure | Varying laws depending on the state |
Pass-through taxation | Self-employment taxes |
C Corporation
C Corporations are where things start to get a bit more complex. If you start a C Corporation - it is its own entity separate from its owners, called shareholders. Some of the benefits are that you are only liable for the amount you invest into the C Corporation, and shares are easily transferrable making transition in ownership quite easy to accomplish. But there are some downsides. Since the C Corporation is a separate legal entity, it must pay taxes. Then you as a shareholder must also pay taxes on dividends paid to you by the C Corporation. In addition, it is very expensive to set up and maintain. You must hold annual shareholder meetings, keep a record of those meetings, and file a tax return for the C Corporation. In addition, the only way to get money out of the C Corporation is though dividends, or selling shares. However, it is quite easy for C Corporations to raise capital, and if you plan to take your business public in the future - a C Corporation is for you.
PRO | CON |
Limited personal liability | Double taxation |
Flexible ownership with shares being transferrable | Complex setup and maintenance |
Unlimited shareholders | Expensive to form |
S Corporation
If you like the structure of a C Corporation but dread double taxation, an S Corporation could be more your style. Overall, S Corporations function similarly to C Corporations but with no double taxation and stricter shareholder requirements. S Corporations function similar to LLCs and sole proprietorships where the profits are passed through to the shareholders personal tax return - there is no taxes paid at the corporation level. One of the complexities though is that you cannot take money directly out of the S Corporation. You must pay yourself a fair and reasonable salary before you can take distributions for the company. This can be complex, and likely will need the assistance of a CPA to determine what is "fair and reasonable." But on the whole I believe that S Corporations are a better option for most people as compared to a C Corporation. Caldeira CPA is itself an S Corporation.
PRO | CON |
Pass-through taxation | Ownership restrictions |
Limited personal liability | Stricter compliance requirements |
Tax savings | Payroll requirements |
Nonprofit Organization
If your business is made to do work for the greater good of society (ex: charity, education, literary, science) and not aimed to make a profit, you likely would start a nonprofit organization. Nonprofits require a fair amount of paperwork to form and maintain, but they offer significant benefits. For example - nonprofits are tax-exempt entities (you must file for tax-exempt status with the IRS), which could save money. They also get liability protection. However, all profits must be reinvested into the mission of the organization. This is a very good option if your business meets the requirements.
PRO | CON |
Tax-exempt status | Extensive paperwork and compliance requirements |
Eligible for public and private grants | Limited control due to board of directors |
Limited liability for directors and officers | Profits must be reinvested into the mission |
Cooperative (Co-op)
Imagine a business owned entirely by its employees and run democratically. Well then you have a co-op. There are quite uncommon, but the rationale behind them is fantastic. Each employee gets the same voting power in the organization, and key decisions are made by that democratic process. However, that does mean that it is hard to make quick decisions as there is a process you must go through. Conflicts can also arise between employees which can harm the business as a whole. Overall, it’s a solid business option if it aligns with your objectives.
PRO | CON |
Democratic control (one member, one vote) | Decision-making can be slow due to democratic process |
Members directly benefit from profits | Limited resources and funding options |
Tax advantages in some cases | Potential conflicts between members |
Deciding on the right business structure is a crucial step in turning your business idea into reality. Whether you’re just testing the waters with a sole proprietorship, collaborating with partners, or gearing up to take your company public, understanding the benefits and pitfalls of each option is essential.
Remember, there’s no one-size-fits-all solution. Your choice should align with your business goals, the level of risk you’re comfortable with, and how you plan to grow. As your business evolves, so might your needs, and it’s perfectly okay to reassess and change your structure down the line.
Take the time to consider your options carefully, and don’t hesitate to seek advice from a legal or financial professional. The right structure will not only protect your assets but also set your business up for long-term success.
Happy entrepreneuring!
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