Select a legal structure for your business

Starting a business requires potential entrepreneurs to make hundreds of different decisions before opening their doors to customers. One of the most important decisions is selecting the right legal structure for your business. How you choose to organize will affect your taxes, personal liability exposure, and fundraising options.

Sole proprietorships are the most common arrangement for people who work alone. This structure is a popular option because it is the easiest to organize and requires no filing with the state. However, one of the biggest disadvantages of sole proprietorship is that the entity does not exist apart from the owner. Consequently, the owner is personally liable for all financial obligations and damages resulting from lawsuits brought against the company. Another disadvantage is that capital can be difficult to raise. Banks are reluctant to lend to sole proprietorships, making homeowners dependent on home equity or family loans.

For businesses with more than one owner, a partnership can be a good arrangement. Each partner contributes capital, labor or experience to make a profit. The partners share in the profits, but as a sole proprietorship, they are also personally liable for debts and damages. One way that partners can reduce personal exposure is by forming a limited partnership. This form consists of general partners who make decisions and assume risks and limited partners without control in the operations in exchange for reduced responsibility. Tax treatment is one of the main reasons why this arrangement is chosen. Profits and losses are transferred to the individual partners.

Limited liability companies, or LLCs, are a type of structure that is becoming very popular. This structure creates a separate entity from the owners. As a result, the owners are not responsible for debts or lawsuits against the company. Unlike a limited company, all members are free to participate in management and are protected against personal liability. LLCs also enjoy passive taxes. However, the tax rules for these structures are complicated. The amount of paperwork is a big hurdle and members must file the articles of organization with the Secretary of State or sign an operating agreement.

The right structure for your business depends on several different factors unique to your business. For example, a small boutique that sells handmade cat collars will obviously have less risk and perhaps less revenue than a company that offers window washing services in high-rise office buildings. Prospective entrepreneurs are advised to contact their lawyer or accountant to discuss the tax and liability consequences of the different entities. A number of free or low-cost resources to help you make a decision are available from your local chamber of commerce, Small Business Administration, or volunteers from the Retired Executives Service Corps.

Selecting the organization for your business is one of the most important decisions you and your partners will make. Research all available options and seek the advice of experienced professionals before making your selection.

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