Menu
Essential Formations for Starting and Growing Your Business
When you launch a new business, you’re faced with a number of important decisions. One of the most formative is the legal structure you choose for your company, which can affect everything from how you’re taxed to how you can defend yourself in the face of a lawsuit.
There are a number of different formations you can choose for your startup, and they all have unique pros and cons. Before making this decision, it can be helpful to know a little bit more about some of the options you have, and how they might ultimately affect your startup’s success.
The Basics: Sole Proprietorships and Partnerships
When you first start generating income on the basis of self-employment, the government automatically classifies you as a Sole Proprietor. What this means in brief is that there is no formal or legal distinction between you and your business. You cannot distinguish between personal assets/business assets and liabilities/business security.
Sole Proprietorships are advantageous in a number of respects. From a regulatory standpoint, they are probably the least burdensome of all legal formations. They allow you to claim pass-through taxation, which means you simply declare profits or losses on your personal tax return. And there is really very little you need to do to establish your Sole Proprietorship on the front end.
Having said that, there are also dangers, most notable legal ones. With a Sole Proprietorship, any litigation that comes your way is directed at you, and you cannot separate yourself from your business interests. Likewise, there is no way to shield your personal interests from creditors.
Still another legal formation to consider is the Partnership. This works almost exactly like a Sole Proprietorship, with one major distinction: In a Partnership, you share both responsibilities and profits/losses with one or more business associates. Still, the same pros and cons that applied to Sole Proprietorships, also apply here.
A More Advanced Option: The LLC
Alternatively, you can choose to register your startup as a Limited Liability Company, or LLC. This is a popular option for small business owners across the country, spanning virtually every industry.
What is an LLC?
When you register your company as an LLC, you actually do create a separate legal entity, which immediately distinguishes this option from the Sole Proprietorship or the Partnership.
What this means is that the business can stand as its own legal entity, distinct from its owner. You can maintain a line between your personal assets/liabilities and your business ones. This provides an important form of legal protection: If someone brings litigation against the business, your personal nest egg or your family’s savings account are off-limits. You can invest in your LLC a little bit more confidently and a little more freely.
In addition to this legal protection, there are several other important benefits that an LLC brings. For example:
- Like Sole Proprietorships and Partnerships, LLCs can be taxed on a pass-through basis, which allows you to avoid the double taxation that Corporations face.
- LLCs are a little trickier to set up and administer than a Sole Proprietorship, but not by much; this is still a fairly low-overhead option.
- With an LLC you have a lot of flexibility with respect to how you want to manage your business, whether that means running it solo, bringing in partners, or outsourcing to a management company.
- LLCs face very minimal regulatory oversight, especially when compared with Corporations.
- Registering as an LLC demonstrates seriousness about your startup, conferring professional credibility.
- LLCs also have opportunities to pursue business loans and lines of credit, with better rates than what a Sole Proprietor could obtain.
Registering Your Startup as an LLC
The process of registering your startup as an LLC involves just a few simple steps. While these steps may vary slightly from state to state, here is their general thrust.
- Choose the state you want to register in. You’re free to register anywhere, but from a tax standpoint it makes the most sense to register in whichever state you are headquartered and making money. So, if your business is in San Diego, you’ll want to register for an LLC in California.
- Select a name for your LLC. LLCs are required to have a name that is not otherwise claimed by another LLC in the same state.
- Appoint a Registered Agent. Your Registered Agent can be an individual or an institution who receives legal correspondence on your behalf.
- File with your state. Submit a document called Articles of Organization, and pay whatever nominal registration fee your state requires.
- Create an Operating Agreement. This is a kind of charter, outlining how you’ll distribute duties and profits between you and your partners.
- Set up a bank account. LLCs should have dedicated business bank accounts, separate from any personal checking or savings accounts.
What About Incorporation?
Beyond the LLC formation, one final option to consider is incorporation.
Forming a Corporation offers you some notable benefits, including some robust legal liability protections as well as greater opportunities to bring in third-party investors. Only Corporations can sell shares, for example.
Corporations also come with much more stringent regulatory requirements, such as mandates to issue shares and to hold annual shareholder meetings. Additionally, Corporations must contend with double taxation, and they are required to make public financial disclosures on a regular basis.
For startups, Corporate status may be desirable when there is a big push to bring in external investors. Otherwise, incorporation may be a little bit too cumbersome and top-heavy, especially for small business owners who wish to remain nimble.
Business Formation Matters
The bottom line: Every entrepreneur must choose a business formation for their startup. And the decision you make can have a long-tail impact on your company’s success. Use this guide to ensure a prudent decision, based on your own startup goals.
Author Bio
Amanda E. Clark is a contributing writer to LLC University. She has appeared as a subject matter expert on panels about content and social media marketing.
Written by:
Similar Articles
Sign up for our Newsletter
Enter your email address to subscribe to this blog and receive notifications of new posts by email.
