You’ve made a big decision: You’re going to launch your own business. It can be both exciting and daunting to become your own boss, but you’re not alone. In recent years, there has been a substantial increase in new business starts, with millions of people going out on their own to open stores and restaurants, launch products, or provide professional services.1
One of the first steps you’ll need to take is deciding what type of legal business structure you’ll choose for your new venture. This decision will impact what you pay in taxes, how you can raise money, and your personal liability exposure. For some types of small businesses, establishing a limited liability company—or LLC—may be the best option. You should consult with qualified legal counsel and tax advisors early in the process to help you determine the best legal entity for your situation.
Key questions to help determine the best structure for your business
Answering a few key questions in consultation with your legal counsel and tax advisors can help you refine plans for your business—and determine what types of structures might be appropriate:
- Who will own your business? — If you’ll own the entire business yourself — or with your spouse — you can choose a simple business structure that includes little or no paperwork. If you plan to own your business with others, you may have to choose a more complex structure that requires additional paperwork.
- Do you have plans to grow significantly with the support of investors? — If your business will have investors or you plan to issue stock, you’ll want to consider corporation options.
- Do I need a business structure that provides liability protection for my personal assets? — If you plan on having customers or contractors visit your place of business — even if it’s your home — or if your products or services could cause injury or financial loss, your business could face liability claims. Some business structures—including LLCs and corporations—help shield your personal assets from claims against your business.
- What is your appetite for paperwork and administrative tasks, including filing tax forms? — Some business entities — such as sole proprietorships and LLCs — are easier to set up and require little paperwork from year to year. Operating as a corporation requires more administrative work—and your business may pay corporate taxes—but there can be operational benefits.
Four business structure options for your new venture
Once you’ve answered the questions above, you’ll be in a stronger position to decide about what business structure to choose. There are various options that may be available depending on your circumstances and state of residence, but here are several options that your legal counsel and tax advisors are likely to recommend:
- Sole proprietorship
This is the simplest, most common business structure in the U.S. If you’re doing business under your own name, you can go right to work as a sole proprietor without any paperwork to file with your state government, although certain business licenses may be required. With a sole proprietorship, you simply pay personal taxes on what your business earns.
One significant downside of using this business structure is that the owner is personally liable for legal claims and debts against the business — meaning your personal assets aren’t protected against business losses. As a sole proprietorship, your business may also be limited in its ability to secure bank loans.
- Partnership
If your new venture will have two or more owners, you can choose to form a general partnership, a limited partnership, or a limited liability partnership. There is often less paperwork required to form a general partnership than may be required for other legal entities, but like a sole proprietor, general partners can be held personally liable for debts and liability claims.
Limited partnerships and limited liability partnerships can offer some liability protections as well as tax benefits compared to corporations. If you choose to form a partnership, discuss with your legal counsel creating a legally binding partnership agreement that details ownership percentages, responsibilities of partners, distribution of profits and losses, and other operational information.
- Corporation
There are two main types of corporations for businesses, S corporations and C corporations. Corporations may provide better protection to owners from personal liability, but they carry a greater administrative burden and can result in higher taxation.
C corporations can issue stock, have an unlimited number of investors, and become a publicly traded company. S corporations, which have limits on the number of investors, allow some profits and losses to be passed to owners to avoid corporate taxation.
- Limited Liability Company (LLC)
An LLC structure offers some of the benefits of both partnerships and corporations, but the administrative burden is lower. There is typically no limit to the number of owners — called “members” — of an LLC, so you can go into business with others using this structure.
LLCs provide some liability and financial protections to business owners. If your LLC business files for bankruptcy or faces a liability claim, your personal assets may be protected. Revenue from LLCs can be passed directly to owners, so your business won’t have to pay corporate taxes. The combination of limited liability protection, administrative simplicity, and lower taxation can often make an LLC the best structure for many new small businesses.
Other key steps to getting your business off to a strong start
Once you’ve decided on your type of business structure in consultation with your legal counsel and tax advisors, consider taking the following steps to move forward:
- Write a business plan — There is no legal requirement to write a business plan to form a business but having a detailed plan that describes your business’s mission, goals, products or services, target market, unique selling proposition, sales strategy, financial projections, and other factors can help get your business off to a strong start. A solid business plan can also help you obtain financing.
- Register your business with your state — Generally, unless your business is a sole proprietorship operating under your own name, you’ll need to register your business with your state. Filing requirements vary by state and business structure, but you’ll have to provide information about your business and pay a required fee. Your legal counsel and tax advisors will be able to advise you of applicable filing requirements.
- Get a federal tax ID number from the IRS — After you register your business with your state, apply to the IRS for a federal tax ID number, also known as an Employer Identification Number (EIN). You may need an EIN to pay employees, to open a bank account, file taxes, and for other purposes. You may need to obtain a state tax ID number as well.
- Obtain needed licenses and permits — Not every business needs licenses and permits, but many do. Depending on your type of business, you may need to obtain licenses or permits at the federal, state, and local level. The U.S. Small Business Administration provides guidance about license and permit requirements.
- Open a bank account — Most likely, you’ll want to collect fees paid to your business and pay contractors, vendors, and suppliers from your business. To do so, your business will likely need its own bank account, separate from your personal account. Having a separate business bank account is also helpful for accounting, paying taxes and fees, and obtaining business loans.
- Investigate insurance options — As soon as your business launches, it can be held liable for injury or financial losses associated with your products or services. Depending on your business structure, you can also be held personally reliable, which means your personal assets can be at risk. Get a quote or contact an insurance agent to explore business insurance options.
- Spread the word — Once you’ve set up your legal business entity, it’s time to attract customers. Let family, friends, and your networks know that you’ve launched your business. Use social media to spread the word as well—and consider setting up accounts under your business name.
Create a team of advisors
When making key business decisions, as well as operating your business on a day-to-day basis, you can benefit from the guidance and services of trusted advisors, including an attorney, an accountant, and an insurance agent and broker. When you start your business, these specialists can help you weigh the pros and cons of different business structures and should be consulted as one of your first steps in considering options for setting up a business.
Your team of advisors can also provide assistance when you take important early steps for your business such as filing paperwork with your state government and the IRS, setting up a payroll system, and obtaining the right insurance coverage for your type of business. The U.S. Small Business Administration also maintains a network of local resources that can help business owners with with financing, marketing, and other operations.
1 US Chamber of Commerce: How the Small Business Sector Has Grown Throughout the Pandemic
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