One of the most important decisions you as a new owner will make is determining which type of business to create. This helps establish whether you will leave the door open to the possibility of partnership or whether you will be the one boss. This choice shapes your ability to get financing, and what kind of financing you can get. While all eyes must be on the development of your enterprise, the future starts with corporate formation.
The common forms of business are the sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC) is a business type allowed by state statute.
- Sole Proprietorships – This is the default position. Your daughter opens up a lemonade stand, she’s a sole proprietor. A sole proprietor is someone who owns an unincorporated business by himself or herself. The sole proprietor gets no liability protection, and most likely will not attract investment outside of a loan without changing form.
- Partnerships – A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Your daughter and your neighbor join forces to man the lemonade stand. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business. Both partners are jointly and severable for the debts of the business.
- Corporations – Subject to double tax but also receiving liability protection. In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation’s capital stock. Shareholders are only liable – in most instances – for the amount they invest.
- S Corporations – While not technically different than a corporation, by making this election with the Internal Revenue Service, you can get the flow-through taxation of a partnership with the liability-limiting protections of a corporation. However, you’ll have less than 100 shareholders and will only offer one class of stock. Foreign persons cannot be shareholders of an S-Corp.
- Limited Liability Company (LLC) – Owners are called “members” and there can be single-member LLCs. There is no maximum amount of members. You receive the flow-through taxation of a partnership with the liability-limiting protections of a corporation. Foreign persons can be members. Members are only liable – in most instances – for the amount they invest.
Think about the product or service you want to sell and imagine which of the above overviews will help you achieve the goal of meeting deadlines, making sales, attracting clients and working harmoniously with others. Really meditate on it. Write out all sorts of scenarios you encountered while an employee, and what type of business could best solve those problems.
Dab Your Toe In The Water Before Diving
One method I’ve strongly advised to is to start your business as a part-time one and let that be a litmus test for success. If you are busy enough to warrant more help — be it a partner, employee, administrator or investor — that should help you in deciding which type of business will suit you best and keep generating revenue.
We recently discussed how different tax structures can factor into your decision making and vice versa. The good news is that you do not need to forever commit to one type of business. If things are going really well and you want to change the status to either bring in partners, shareholders or eliminate them, you can change the business type to reflect that.
We’ve established a brief overview about the most common types of small businesses and what you’ll consider before you contact Brinen & Associates. We’ll review your idea and status and let you know if we agree with your plan or would propose another option.