I recently had a conversation with a friend that is running her own successful small business. The issue I saw in her operation is too often the case with small business owners. She’s doing well; she gets lots of business, has a great reputation and a strong social media presence with lots of 5 star reviews. Now to the issue. We hadn’t spoken in a while, so in catching-up we discussed how we both started our own business ventures. I went through the details of setting up my entity and asked her what legal structure she was operating under. She looked a bit confused, so I rephrased and asked “what type of business entity did you form for your business?” I was surprised to learn that she had not set up an entity at all and was operating only as a sole proprietor. After I made it clear that she is personally liable for all the risks of her company, she was in my office the following week to set up her business entity.
Unfortunately, a large majority of small business owners have not formed a legal entity for their business and leave themselves subject to full personal liability. It’s my opinion that setting up your business correctly starts with choosing your legal structure. There is not just one legal structure that is best for all small businesses. There are a variety of structures that can be considered, but for the purpose of this discussion I’ll limit it to Sole Proprietorship, General Partnership, Corporations and Limited Liability Companies.
Sole Proprietorship
A sole proprietorship is one individual or married couple in business alone. The sole proprietorship is not a legal entity. It simply refers to a person who owns the business and is personally responsible for all of the businesses financial and legal liability.
General Partnership
A general partnership is an arrangement by which two or more persons agree to share in all assets, profits and financial and legal liabilities of a business. Such partners have unlimited liability, which means their personal assets are liable to the partnership's obligations. Personal liability is joint and individual for the general partners who are responsible for the obligations of the partnership. A general partnership is not treated as a separate taxable entity. Its business income is taxed through each general partner's personal tax return this is known as flow-through taxation. Limited Partnership, Registered Limited Liability Partnership, Limited Liability Partnership (LLP) and Limited Liability Limited Partnership (LLLP) are variations to a general partnership that may be considered.
Corporation
A corporation is a a company or group of people or an organization authorized to act as a single entity. A corporation has all the legal rights of a person, except for the right to vote and certain other limitations. This entity also provides limited liability. Therefore, although the shareholders have the right to participate in the profits, through dividends and/or the appreciation of stock, they are not held personally liable for the company's debts. C corporations, S corporations, Professional Service Corporation, Design Professional Service Corporation, Religious Corporation, Benefit Corporation and Nonprofit Corporation are variations to a Corporation that may be considered.
Limited Liability Company (LLC)
A limited liability company (LLC) can be an individual or group of members that participate in conducting business as a privately owned company. A LLC may be owned by a single individual, two or more individuals, or by a corporation or another LLC. Generally, members of the company cannot be held personally liable for the company's debts or liabilities. Limited liability companies have the availability of flow-through taxation to the members like partnerships but can elect its classification for federal tax purposes. A Professional Service Limited Liability Company (PLLC) is available for people who will provide licensed professional services such as architects, medical practitioners and lawyers.
* When considering your options, I recommend consulting with not only legal professionals but also tax and financial professionals before deciding a particular structure works best for your small business.