Creating a small business can be a long and drawn-out process. You spend so long doing research and brainstorming in preparation that it may not seem real when your company starts to take shape.
The next step after putting in the research and coming up with a plan is to establish your business officially. You need to legally organize your business in the government’s eyes before you can get to work.
To do this, however, you need to choose a business entity. Your business structure will determine how you proceed.
What are Business Entities?
A business entity is the structure your small business takes before the law and the government. As a small business owner, you have several different choices for what kind of company to file to create. The most common structures are limited liability companies, S-corporations, C-corporations, sole proprietorships, partnerships, and nonprofit companies.
Your business entity determines the way authority and control are held in your company. The way your business pays taxes, the way profits and losses are shared, and even your degree of personal liability are all shaped by the business entity.
How to Choose a Business Entity
You shouldn’t rush through the process of choosing a business entity. You need to be sure about what exactly you want from your business.
Your decision will depend on what your goal is with your business. What do you want to do with this business? Do you wish to earn money and sell it, or are you hoping to hold onto it and pass it on to family?
You should also consider the financial side. How will you raise money to build this company? Are you willing to put your own money and financial stability on the line for more control and a more significant stake in the profits? Are profits even a critical concern for you, or are you more interested in the good your company can do for society?
Considering all of these factors carefully will help you determine which business entity is right for your company.
Limited Liability Company
A limited liability company (LLC) is an especially flexible structure popular with many new small business owners. As the name suggests, this entity limits liability for its owners, shielding your personal assets to an extent while keeping the company flexible.
The members of LLCs can change the profit share and decision-making control simply by changing the operating agreement together. As far as taxes are concerned, each member of the LLC has to include their share of the company’s profits on their personal income tax return.
Many small businesses are sole proprietorships. If you don’t file with your secretary of state but start selling items you make at a farmer’s market, you’ve effectively started a sole proprietorship.
This means that your business primarily depends on you and you alone. All of the profits and important business decisions are yours, but you’re also personally liable for any debt incurred by your business. Sole proprietors include their business income on their personal return.
Partnerships are another common business entity. They’re similar to sole proprietorships because owners bear full responsibility for company debts, and the company is not taxed separately from the small business owners.
The particular profit share and chain of command in your company depends on the partnership agreement. In a general partnership, all general partners participate in the operations of the business and share liability.
Corporations tend to cost more money to start, but they offer much greater liability protection for those starting the business. A corporation is a separate legal entity from the individual owner, which makes taxation more complicated.
In an S-corporation, all of the profit of the business flows through the business to the shareholders who own the company through stock. Then each shareholder and employee include that income on their personal return.
While they’re mostly similar, there are key distinctions between C-corporations and S-corporations. For example, C-corps can issue many more types of stock, and they have to file a separate business tax return. Most big businesses are some type of C-corporation.
While it may be much easier to raise money and protect your assets with a corporation, you give up some measure of profit control and authority over the business’s future when you sell stocks.
Another type of entity is the nonprofit corporation, most commonly formed as a 501(c)(3) corporation. This type of business is exempt from taxes on business profit, but you must still stay current with IRS documentation.
Tax-exempt nonprofit 501(c)(3) corporations must dedicate themselves to meeting a charitable need or serving the public good in some way that meets IRS requirements.
Once you’ve settled on your business entity choice and prepared the proper paperwork, all you have to do is pay the fees and file the paperwork with the secretary of state in the states where you’ll be operating.
Then you’re established and ready to go. You’ve got a strong foundation for your business, and you’re ready to move forward with product development and production.