Here are the Pros and Cons You Should Know
Walt Disney said it best when he said, “The way to get started is to quit talking and start doing,” so if you’ve been talking about making your startup or business idea a reality, it’s time to get started. And one of the first (and most important) steps to take is determining which business structure—Sole Proprietorship, DBA (Doing Business As), Partnership, LLC (Limited Liability Company), INC Corporation, or Nonprofit—is right for you.
The reason this first step is also so important is that the structure your business falls under will have an enormous impact on everything from your taxes to your personal liability to your ability to get credit. While the laws relating to business structures will vary slightly state to state, below is an overview of some of the most common models, along with the pros and cons of each, to help you make the best decision that drives success.
A sole proprietorship is an unincorporated business and the simplest business structure you can choose. In a sole proprietorship, the company is owned by one person (you) who will report profits on a Schedule C when filing an individual tax return. You will also need to file a DBA form with your State Business office to get a certificate needed to open a business bank account.
PRO: This is the easiest structure for taxes. You’ll be considered a “pass-through tax entity,” which means that all your business profits or losses will be reported solely on your individual tax return.
CON: You’ll likely have trouble getting business loans with a sole proprietorship, as banks and lending companies are hesitant to give them to sole proprietors.
A Partnership is also an unincorporated business, although in this structure, there are multiple owners and all profits (as well as losses) are divided then reported across all owners’ tax returns. The Partnership structure generally falls under general, limited, or joint venture.
PRO: Taxes are easy, since all profits and losses are distributed evenly among the partners and noted on their individual tax returns.
CON: There are added expenses, since a Partnership Agreement is important and will require paying a lawyer to draw up the paperwork.
LIMITED LIABILITY COMPANY (LLC)
Form an LLC, I recommend Legalzoom, which reduces the personal liability of the owner or owners of a company in that profits can be taxed on either a member level or a corporate level. This offers the flexibility of operating like a Sole Proprietorship or Partnership if there are profits—namely, reporting business gains on individual tax returns. If there are losses, an LLC allows those losses to be accounted for at a corporate level vs. individual level, so there is no need to file them on their individual tax returns.
PROS: If losses occur in the business, members of an LLC are not always held personally liable for it. This means if a member has considerable personal assets, those assets will be protected in case of a significant profit loss for the business.
CONS: Forming an LLC is not as easy as forming a sole proprietorship or a partnership. There are significant steps you’ll have to take that will vary from state to state, including filing articles of organization, creating an operating agreement, and obtaining all industry-specific licenses or permits to operate your LLC.
In an S Corporation, all profits made are reported on shareholders’ tax returns, although those shareholders do have limited liability in case of business loss. Also, there can be no more than 100 shareholders and one class of stock. In a C Corporation, profits are taxed at the business level and then again when the shareholders’ earnings are distributed. In a C Corporation, classes of sock and number of shareholders have no limits. Then, there is also the B Corporation, which is a corporation that provides benefit in that it is structured around a cause (although not a Nonprofit). Administratively, however, a B Corporation is operated in the same way a C Corporation is.
PRO: Your personal liability for business profit loss will be protected completely, and rather, taken on by shareholders.
CON: There is much greater administrative complexity when your business is structured as a Corporation, requiring a lawyer and an accountant, which account for extra expenses. You’ll also need to stay compliant and meet deadlines, as well as file paperwork and forms to avoid penalties.
A Nonprofit falls under the umbrella of a Corporation but is a company focused on performing civic, religious, charitable or educational duties. In a Nonprofit, a Board of Directors must be present.
PRO: Your personal liability is protected in cases of operating losses and you’ll be doing something that has a significant impact on the world.
CON: Nonprofits face considerable reliance on fundraising and can neither be bought nor sold.
Five Questions to Ask Before Determining Your Business Structure
When considering which of the above business structures to use, it’s important to sit down and think about your goals for your startup and your unique financial situation. Some questions you will probably want to ask yourself (and I highly suggest writing these down, along with your answers!) are:
- How much risk to my personal assets can I tolerate?
- Do I want to be personally taxed on the business profits?
- Do I want a formal or informal management structure?
- How much administrative complexity can I handle?
- What are my long-term goals for my business?
With these questions in mind, it will be easier to determine which structure might work best for you by simply considering the pros and cons of each. Only then will you have a clear picture of the structure that will best benefit your business goals and personal success.