Setting up and operating a small business can be very exciting, but there are also some concerns that have to be addressed. One of those is the type of structure you are going to have for your business. A lot of small companies are sole proprietorships, but others are LLCs or different types of corporations, like S Corps and C Corps. All of those terms can seem confusing, but they do not have to be. When you understand what the terms mean and how the choice of structure can affect your business, you will be able to select the option that is right for you.
Many Small Businesses Are Sole Proprietorships
For a very small business, the most common business structure is the sole proprietorship. Unfortunately, a sole proprietorship can leave a business owner vulnerable to financial and legal problems if the business does not perform well. The setup process for a sole proprietorship is very easy, which is a large part of the reason why people choose this option when they start up a business. Essentially, they can just get any licenses that are required by their profession, state, or city, and start operating their business without other legal intervention.
The setup cost is also low, and taxation is based only on the personal level. In other words, there are no “business taxes” that have to be filed. The individual (sole proprietor) is taxed on their income from the business, and they fill out a standard 1040 tax return. They do have to include a Schedule C for their business, but there are tax advisors and even software programs that can be used to ensure that the return is handled correctly. Having a personal tax filing as opposed to a corporate filing makes things easier, but it also shifts all the liability onto the sole proprietor. That can be very risky, and is not a good choice for all types of businesses.
Choosing an LLC vs. Incorporation
For business owners who do not want the liability of a sole proprietorship, incorporation may be the best option. Incorporating provides protection from liability that a sole proprietorship doesn’t offer. When a business that is incorporated gets sued or has other legal or financial trouble, it is the assets and liabilities of the business that are considered, instead of the assets and liabilities of the owners. Each type of incorporation is a little bit different, though, and it is very important to determine whether an LLC is the right choice versus more standard forms of incorporation. Like any choice in the business world, there are pros and cons that have to be considered.
The Limited Liability Company (LLC)
When it comes to setting up an LLC, the level of difficulty is moderate, compared to the ease of setting up a sole proprietorship. Setup costs are also higher than they would be for a sole proprietorship, and personal taxes (as opposed to business taxes) are still paid. However, there is no personal liability for the financial obligations of the business. There are more record keeping requirements with an LLC as opposed to a sole proprietorship, but the reduction in liability is often worth the extra effort required to make sure records are being handled the right way.
There is a high level of flexibility with an LLC, which is one of the reasons that so many people like it. An LLC can be a good choice for small businesses that are not focused on raising money from investors, and that want to have flexibility in areas like taxation and management. Getting all of that along with financial protections can make the LLC a very good choice for many different kinds of companies.
The S Corp
An S Corp is one option when incorporation of a business is being considered. The setup process is rather difficult and it can be costly, so it is important to get a knowledgeable attorney or other party to help with the actual creation of the business. That can reduce the chances of setting something up incorrectly, and of causing a problem for the people who own the company and who were trying to legally and financially protect themselves. An S Corp still allows for a personal level of taxation, making tax returns easier to manage, but, like an LLC, it removes the liability from the owner personally and places that liability onto the business itself.
One of the most significant issues to note with an S Corp is that the record keeping requirements are extensive. It is not possible to just keep a simple balance sheet or other type of list, and there are forms and other pieces of information that have to be handled in a particular way. As such, an S Corp generally needs either an accounting department, or the ability of an accountant who is very comfortable handling the tax returns and other filings of this type of business. Without a knowledgeable person like that available, it is very easy for an S Corp to make financial and legal mistakes.
The C Corp
A C Corp is also difficult to create, and can be expensive, so a knowledgeable person is recommended when setting up this type of structure for a business. While this corporation is very similar to a C Corp, there is one major difference. Both personal and business levels of taxation are required. That double level of taxation can make a C Corp an expensive proposition for most small business owners. A company that needs to raise investor capital or that wants to go public at a later date may want to consider the C Corp structure, but it is not a choice that many small business owners would elect to take.
No matter which small business setup you choose, remember that your business will grow and change over time. Starting out as a sole proprietorship can be the easiest way to get your business off the ground, and you may see that business develop into something bigger later on. Then, you may want to consider an LLC or incorporation.