When you’re starting a business, it’s easy to get overwhelmed. There’s a lot to do — not the least of which is deciding what type of business entity you want to use. The decision should be made early not only because it may be difficult to change later, but because it will also have significant financial and legal consequences.
In general, most start-ups and small businesses will operate under one of these structures:
By far the simplest formation, sole proprietorships require no corporate formalities or special paperwork. Taxes are relatively simple. However, you also have more personal liability, and you may find it difficult to get funding and credit.
General and limited partnerships are useful any time a business has two or more owners. They’re fairly easy to form and don’t require the formalities of a corporation. Further, you can deduct most business losses on your personal income taxes. The shared risk makes this attractive to many. However, that shared risk can sometimes be a liability if you don’t choose your partners carefully.
An LLC is an easy way to create personal protection against asset losses (including lawsuits) while operating easily under a partnership agreement, but it doesn’t particularly have any tax benefits. The operating costs can also be higher — but it avoids the formalities involved with maintaining a corporation.
Incorporating your business creates a legal entity that exists independently from the company’s owners. Corporations require a bit more paperwork and must create bylaws and hold board and shareholder meetings. Taxes are also much more complicated. On the other hand, your personal assets are better protected from loss and you may have a much easier time raising capital and credit.
It’s often difficult for inexperienced business owners to decide which structure to use. After all, no one structure is right for everybody. When you’re having a hard time deciding which way to go as you form a business entity, it may be useful to talk to an attorney with experience in business development.