Starting a new company requires entrepreneurs to deal with a lot of challenges, one of which is determining the best company structure for startups.
A proper structure is essential for laying a solid foundation and ensuring the company’s future growth. This article will provide an overview of effective business structures for startups. Entrepreneurs can then use this information to conduct additional research and find the best choice.
What is a company structure?
A company structure is how a business is legally organized in a given jurisdiction. It determines the formation and operation of the company. When you choose a startup business form, you are deciding on the company owner, the responsibility for obligations, the amount of taxes, and other factors.
To ensure your company’s long-term growth and smooth operation, consider the key characteristics of each entity type and align them with your expectations and goals. In the US, there are four most common options for startups: sole proprietorship, partnership, limited liability company (LLC), and corporation.
The importance of startup company structure
The business structure you select has an impact on everything from day-to-day operations to long-term viability. Below are the major aspects affected by entity form:
- Forms the operational and functional structure
- Determines the extent of the owner’s liability
- Impacts the tax implications of the startup entity
- Defines the flexibility to raise capital
- Ensures the safety of the company name and trademark
- Increases the credibility of the company
The best legal structure for startups
This is the simplest structure to set up and allows the owner to control the business operation completely.
When you start your own business, you’re automatically classified as a sole proprietorship, which does not require registration as other company structures do. If necessary, you can still register a trademark as a sole proprietorship.
There will be no legal distinction between you and the entity, which means you will bear full responsibility and liability for the business’s debt, assets, and other obligations.
Due to pass-through taxation, sole proprietorships only pay personal income taxes and do not file business tax returns.
Pros of a sole proprietorship
- Simple and low-cost to establish
- The owner takes control of all business operations
Cons of a sole proprietorship
- Difficult to raise capital and borrow money from banks to run the company.
- The owner is personally liable for all liabilities incurred by the business.
If you’re looking to collaborate and build a business with someone special, whether it be family members, friends, or colleagues, forming a partnership is the best way to start. Not only will this create an obligation between all parties involved but also promote collaboration of ideas and skill sets.
A partnership is formed by two or more people and is classified into two types: limited partnerships and limited liability partnerships.
A limited partnership (LP) has only one general partner, who is responsible for the business’s operation and has unlimited liability for all business and personal assets. The remaining members are all limited partners, who only contribute capital and have no control over the company.
A Limited Liability Partnership (LLP) has many members who share the same decision-making power and have unlimited responsibility for the business’s operation. Liability, however, will be limited to each member.
Each member will be protected from the debts of the other members and will not be held liable for their actions.
Partnerships are considered pass-through entities, which means profits will be distributed directly to partners and taxed as personal income rather than corporate income. In addition, members (except limited members) are required to pay self-employment taxes of 15.3%, which include 12.4% for social security and 2.9% for Medicare.
Pros of Partnerships
- Easy setup, little paperwork required
- Cost savings, no double taxation
Cons of Partnerships
- Each partner is personally liable for the company’s liabilities and debts.
- In the absence of a partnership agreement, management and supervision issues can arise.
Limited liability company (LLC)
An LLC is a combination of a corporation and a sole proprietorship. It protects business owners’ liability while also simplifying the establishment process.
LLCs give members flexibility in how profits and losses are shared, as well as how taxation works. Single-member LLCs are automatically taxed as sole proprietorships, whereas multi-member LLCs are taxed as partnerships.
Moreover, members can choose for the company to be taxed as an S corporation or a C corporation. Members, on the other hand, are considered self-employed and must pay self-employment tax.
To form an LLC, entrepreneurs must pay a filing fee of $100–$800 and provide an article of organization, which is part of the official legal document to form a limited liability company at the state level.
Pros of a limited liability company (LLC)
- Entrepreneurs have limited liability protection, avoiding the risks of company debt.
- The ability to choose whether to be taxed as a sole proprietor, partnership, S corporation, or C corporation.
- The number of members is not limited.
Cons of limited liability company (LLC)
- Limited capital raising because the LLC cannot issue shares
- The annual and maintenance fees can vary greatly depending on the state.
- Can bear the risk because it is a new type of business that has not been strictly regulated by law.
A corporation is a legal entity distinct from the business owner. C corporations and S corporations are two common types of corporations.
As for the S Corporation, profits are distributed directly to shareholders and are only subject to personal income tax. However, because S Corporations cannot have more than 100 shareholders and all shareholders must be US citizens, they are not suitable for investors who are only permanent residents of the United States.
Many states in the United States, however, do not recognize S corporations and apply the same regulations to C corporations.
In the C Corporation, profits and taxes are calculated separately and subject to separate liability. This is the best type of personal liability protection for business owners. It does, however, have higher setup and operating costs, as well as more stringent operating procedures, accounting records, and reports. Profits will be taxed twice: once at the 21% corporate rate and again at the personal rate when dividends are distributed to shareholders.
C-Corps have a significant advantage in the ability to raise capital because they have the right to offer shares and can also recruit talent with shares.
Pros of Corporation
- All the shareholders have limited liability, which means they are not responsible for the company’s liabilities and debts
- Easily attract investors and raise funds because of the ability to issue stock.
Cons of Corporation
- Costly and rigorous to establish
- S-corps have a limited number of shareholders, whereas C-corps are taxed twice.
How to choose a suitable structure for your startup?
When deciding on an appropriate startup structure, entrepreneurs have to carefully weigh the pros and cons of each option. Below are some key factors that can help you decide which setup will work best for you.
Consider your company’s future
Thoughtful consideration must be given to your entity structure, as it will not only affect the current state of your business but also it is future.
Crucial elements such as legal protection, taxation rates, number of owners and shareholders, advantages that come with the chosen model, and registration process should all be taken into account when making this decision.
With a well-structured plan for the present and beyond at hand, you’ll ensure success for years to come.
If you are looking for the most cost-effective way to establish a business, sole proprietorship and partnership may be your best bet. Nevertheless, if you desire to grow your business operations while gaining access to additional investments and bypassing corporate liabilities, forming a corporation could be the optimal choice for entrepreneurial success.
Think about Licenses and Permits
Licenses and permits are important factors that all entrepreneurs must keep in mind when setting up a business. With each state in the U.S. having its different requirements for business licenses, businesspeople must have an understanding of both their industry’s laws as well as local, state, and federal regulations.
Ask for advice
Researching can be an intimidating and tedious task for entrepreneurs, but seeking guidance from experts is the most successful approach. These professionals will offer invaluable advice that enables you to select a sound structure.
- Sole proprietorships are the optimal option for solopreneurs who prioritize protection and have few financial assets to protect.
- Partnerships are an ideal option for businesses with multiple owners, including but not limited to lawyers and real estate agents.
- For small businesses that need liability protection while also looking to save money, forming a limited liability company (LLC) is an ideal solution.
- If you’re seeking to both safeguard your assets and expand your business, an S Corp or C Corp is a good choice, offering reliable protection while enabling efficient growth opportunities.
When it comes to choosing a company structure, there is no one-size fits all solution. However, the C Corporation remains the perfect choice for startups due to its ability to protect business owners from liability and facilitate high levels of fundraising.
With so many advantages, incorporating a C Corporation in Delaware has become the obvious choice for entrepreneurs and startup founders alike. Thanks to its business-friendly atmosphere, Delaware is undoubtedly the most suitable option when it comes to ensuring success and long-term growth.
BBCIncorp is always willing to support entrepreneurs launching a startup in the U.S. If you need any help or advice, do not hesitate to contact us via email at email@example.com.
Disclaimer: While BBCIncorp strives to make the information on this website as timely and accurate as possible, the information itself is for reference purposes only. You should not substitute the information provided in this article for competent legal advice. Feel free to contact BBCIncorp’s customer services for advice on your specific cases.
- What is a company structure?
- The best legal structure for startups
- How to choose a suitable structure for your startup?
- Final thoughts
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