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What Business Formations are there?

Before you can register your business in your state, you need to know how your business is organized. There are several different organizations you can choose for your business, but in this post, I’m focusing on the four most popular types of business organizations: sole proprietorship, partnership, corporation, and limited liability company.

Nothing in this blog post should be construed as legal advice and, if you have any questions or want to know more about the best way to organize your business, you may want to seek legal counsel.

Sole Proprietorship

A sole proprietorship is a business with a single owner (i.e. the business does not exist separately from the owner). All incomes or losses are recorded on the proprietor’s personal income tax return. In some states, there may be fewer registration fees to register a business as a sole proprietorship. Under a sole proprietorship, owners have total flexibility when running the business, but they are equally fully responsible for any liability associated with the business. Additionally, filing taxes under a sole proprietorship is simpler because no additional legal paperwork is necessary.

Organizing a business as a sole proprietorship is ideal for someone who is starting a one-person business, with limited financial investment, and will not be hiring any additional employees. If, however, you have dreams of taking out a loan to grow your business or eventually hiring employees, a sole proprietorship may not be for you.

Partnership

A partnership is a business with two or more owners. There are three forms of partnerships: general partnerships, limited partnerships, and limited liability partnerships. General partnerships tend to arise from an informal agreement – and can be formed with an implied understanding between two business owners. In general partnerships, both owners invest their time, money, and resources to the business and are both fully personally liable for any business debts. In other words: if the business tanks, you are still potentially responsible for the full amount of debt incurred.

Limited partnerships require a formal agreement (like a contract) between the two owners and requires a certificate of partnership with the state where the business is registered. However, a limited partnership allows both owners to invest their time, money, and resources to the business but limit their personal liability for business debts based on their proportion of the investment. So, whoever invests the most resources (typically the General Partner) will also be most likely to be personally liable for any debts.

Limited liability partnerships (LLP) are nearly identical to limited partnerships, but under a business organized as an LLP, there are no general partners: everyone has limited personal liability for any debts incurred by the business. However, in some states, LLPs are reserved for professional groups only (like lawyers or accountants).

Organizing a business as a partnership is ideal for two or more people who are starting a business and want to take advantage of the reduced financial burden or the extra set of hands. However, if either party is concerned about their potential liability, splitting profits, or relinquishing full control of the business, then you may want to reconsider whether a partnership is the right choice.

Corporation

A corporation is a business that exists separately from its owners. Corporations function the same way that any individual does in the business world: corporations can enter contracts, borrow money, file lawsuits or be sued, and pay taxes. There are several types of corporations, most notably the C-Corporation, S-Corporation, and Non-profit Corporations (like charities, or educational or religious organizations).

A corporation usually costs more to register than other business formations. Corporations also require more paperwork than other business formations (like the Articles of Incorporation, Bylaws, Minutes, and more). A corporation must have a board of directors, annual meetings, and must publish their financial statements. Despite the stricter requirements, however, a corporation provides the greatest protections to the business owners when it comes to personal liability.

If you don’t like the idea of ultimately having to answer to shareholders for your business decisions, or if you are not fond of frequently doing paperwork, then a corporation may not be the right choice for you. However, if your business is inherently more risky and more likely to incur liability (e.g. if you work with highly combustible products), or if your heart is set on having the flexibility of choosing your tax structure and eventually issuing stock options, then a corporation may be a good fit.

Limited Liability Company (LLC)

A limited liability company (LLC) is a business that offers business owners liability protection and certain tax advantages, making it the “happy medium” between a limited liability partnership and a corporation. LLCs are particularly attractive because they offer so much flexibility to the business owners.

However, LLCs do cost more than other types of businesses to form and operate, and in many states, you may be required to pay annual fees and taxes. Additionally, LLCs are not the best business formations if you think you are going to be relying on outside investors in the future. In other words, LLCs are perfect for businesses where the owner thinks they may become successful enough to be sued, but are not interested in being a Fortune 500 company.

There is a reason why LLCs are so popular: they can be used for a business of any size, almost everyone is seeking to limit their personal legal liability as much as possible, and LLCs are easy to form and operate. Unless you have a compelling reason to organize your business under a different formation (or your lawyer or tax professional suggests otherwise), an LLC is generally considered a safe default.

Still Not Sure Which is Right For You?

If you’re still not sure which type of business organization is right for your goals be sure to reach out to a attorney.

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