By Adam S. Juratovac (@AdamJTheLawyer)
www.JuratovacLaw.com
What’s the difference? Every early stage start-up and entrepreneur knows that when she has her business, she needs to find the right legal structure for it. This decision requires business-based analysis but for a seasoned entrepreneur, she has a good idea of what she needs. This article will go over 5 things that an entrepreneur needs to know about choosing the right legal structure:
1. Sole Proprietorships are effective for small digital businesses.
Sole proprietorships are some of the most common business entities because it doesn’t require filing papers, such as an LLC or corporation. Sole proprietorships are easy to set up and maintain because if an entrepreneur has a side business, freelance gig, or side hustle, she is automatically a sole proprietor. She is still a sole proprietor even if she hasn’t registered her business with her city or applied for any licenses or permits. Licensing and permitting for her business is something that she should be aware of. A positive tax purpose about being a sole proprietor, an entrepreneur only gets taxed once on the income of her business. That income will be taxed on the sole proprietor’s (entrepreneur’s) tax return.
2. Partnerships are more common than you think.
A partnership constitutes as two or more entrepreneurs working together in a business with a goal of obtaining a profit. This means that a business that has more than one owner and that has not filed papers with the state to become an LLC or corporation is a partnership. Entrepreneur’s need to have a heads up because if they do not have a partnership agreement or contract in place of how the business will be run, the state provides default rules that the entrepreneurs need to abide by. For example, if there is no profit-sharing agreement, profits will be shared in the same proportion as the ownership interest of the entrepreneurs in the partnership. In addition, losses that the business incurs will be distributed similar to the profits. This default rule controls only if the partnership doesn’t have a set rule in place. This can be worrisome for partnerships that include partners that get involved with an investment of money and partners that are involved based solely on sweat equity.
3. LLC’s are a great way to protect its members.
LLC’s are a great vehicle for closely held businesses because when properly formed, it provides its members with protection against actions and liabilities of the LLC. That means, if the business defaults on contracts entered with other companies, the other companies can sue the LLC for its assets, but the member’s personal assets are mostly protected. A great tax benefit for an LLC as opposed to a C-Corp is that an LLC is a pass-through entity. That means that the income earned by the LLC will only be taxed on its members personal tax returns. This is different than a C-Corp, when a C-Corp earns income, that income gets taxed at the entity level (the C-Corp gets taxed), and when the income gets distributed to its owners, the owners also get taxed. That means that income from a C-Corp gets taxed two times before getting to the owner’s pockets.
4. Corporations are great for funding.
C-corps are the preferred entity for venture capitalists investing in a company. There are several reasons for this, one is that LLCs are primarily for more closely held or managed companies and C-Corps can be created for scale. When a venture capitalist invests in a company, she typically wants to see it grow exponentially and eventually go public. Those steps are more easily accomplished, on a legal level, with a C-Corp. However, if you have an LLC that has the potential to go public, there is a process to turn your LLC into a C-Corp, so don’t worry too much.
These are a rundown of the different business structures or entities that an entrepreneur can choose from. However, an entrepreneur should always be cognizant of scalability. If she has a company that she wants to grow to a small family business, she may not need to form a C-Corp, a sole proprietorship may be fine. If she has a company that she wants to go BIG, maybe she can start as a sole proprietorship with the intent of forming an LLC when she starts entering into business relationships with other parties. There are many factors that an entrepreneur must think about and they are dependent on the goals, intent, and purpose of the business.
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If you have any questions about this article or the benefits and detriments of each structure, feel free to contact me at Adam@JuratovacLaw.com.
NEXT WEEK’S ARTICLE: When An Entrepreneur Should Incorporate Her Business
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