If you are planning to open a new business, it’s important to think critically about your structural formation options. Under most circumstances, it isn’t lawful to operate a business within a state unless you’ve formally registered your operations. That initial registration process is called formation. If you expand your operations to other states in the future, you’ll simply need to register your already-formed company there as well.
The structure that you choose for your business as you start the formation process will be consequential in a number of ways. Your choice will affect the way in which your business is taxed, whether you can be held personally liable for its debts, which state and federal reporting requirements will affect your company, etc.
As a result, you shouldn’t choose a business structure without weighing the pros and cons of each approach very carefully.
The four primary options
Each of the following options offers benefits and potential drawbacks:
- Sole proprietorship – Owned by one person, taxed on their personal return, no personal liability protection, few reporting and startup requirements and maximum managerial flexibility
- Partnership – Usually functions like a sole proprietorship but is owned by multiple people/entities
- Limited liability companies – Can be owned by one or more “members,” relatively flexible managerial structure, some startup and reporting requirements, personal liability protection and can be taxed on personal returns or as a corporation
- Corporation – Strict managerial structure and reporting requirements, owned by shareholders, maximum personal liability protection, taxed as unique entity and unique fundraising opportunities
Each structure formation option works best for different business types and entrepreneurial visions. Understanding your options and thinking about each critically in turn will help you to make the best decision for your unique enterprise.