Starting up a business can be one of the best decisions you make, or one of the costliest, often depending largely on how you go about it. One of the first decisions any potential self-employed individual needs to consider is what sort of business structure they’re looking at. Assuming you don’t have the resources to start up a business entirely out of your own pocket, you’ve got a couple of basic options – forming a partnership, a corporation, or a limited liability company.
Partnerships
When several people go into a business together, by default they are legally considered a partnership. Forming a partnership doesn’t require any sort of legal documentation, so forming one is easy. Also, it doesn’t have the same sort of tax restrictions corporations face, which will be discussed shortly.
The biggest disadvantage of a general partnership is unlimited liability. Unlimited liability means that if the business runs into serious trouble down the line and is forced to declare bankruptcy, the resources of the partners can be seized in order to repay any outstanding debts that the partnership might possess when it is dissolved. This can be a huge risk for potential partners, especially during questionable financial times.
Corporations
This is remedied by the single biggest feature of small, privately-held corporations, which is limited liability. Because a corporation is considered a separate entity from the individuals who formed it, the founders aren’t directly responsible for repaying debts if the corporation files for bankruptcy. Instead, only assets associated with the business are liquidated, and any remaining debt has to be accepted as a loss by the people on the other end of the line.
Another big advantage of corporations is that they have the option of issuing stock. If you require substantial capital and are capable of dealing with the regulation that being openly listed requires, forming a corporation and issuing stock is certainly one method to generate a substantial amount of money.
The biggest downside of this is that since the corporation is considered a separate entity, it is taxed seperately from the owners. This means that income is usually taxed twice – first when the corporation makes it, and a second time when the corporation distributes excess earnings back to the shareholders.
Limited Liability Companies
The solution to this, at least for smaller businesses, is to form a limited liability company (LLC). Like standard corporations, LLCs provide limited liability to owners, so personal assets are much more secure in a worst case bankruptcy scenario. At the same time, LLCs are taxed at the federal level however the owners wish – usually as a partnership, with earnings taxed only once at the individual level, not at the corporate level as well.
Though this can often be the ideal solution for many owners of small businesses, there are a few disadvantages worth noting. First, LLCs aren’t always treated in the same way by state income tax services in the same way as the Internal Revenue Service. As such, anyone using an LLC who lives in a state with income tax should consult their state tax laws to determine how to handle LLCs. Second, unlike a partnership, an LLC doesn’t simply come into existence as soon as two or more people go into business together – it needs to be formed legally, with the proper documents filed to back up the status.
Final Thoughts
In the end, what sort of company you form really depends on what your requirements are. If the business is intended to be small and temporary, with people you know and with little chance of liability accruing, a partnership is probably sufficient. If you require the large scale capital that stocks can provide and have the resources and knowledge corporations require for their maintenance, a corporation might be right for you. However, for most people it’s probably worth your time to fill out the forms for a Limited Liability Company. Protection from liability and flexibility in taxation make the LLC a good base option for anyone looking to open up a small business.