How you choose to structure small business – whether it is a home decorating business, local handyman shop or senior assisted living community – can have a major impact on your taxes, retirement saving options, liability and the ability to grow through new hires and additional business partners.
Discuss your business structure and your personal goals with a financial advisor so that you are clear on the impacts of your choice.
Easy to establish and also dissolve, a sole proprietorship is the most common small business formation choice. A sole proprietorship indicates that you work alone and thus have complete control of your business and its profits. But it also means that you face complete liability for the business: your personal and other assets may be at risk in any litigation or bankruptcy. Sole proprietors may be required to have various city or state business licenses. This business structure may be helpful for those with more than one source of income (such as a full-time job and a sole proprietorship for other business activities).
If you and one or more partners plan to share ownership of a business, you will need to draw up a legal agreement outlining the partnership’s terms. You will also see the profits from the business flow to personal tax returns. Who owns what percentage of the business? Who is contributing to startup capital? Who is responsible for what kinds of decisions or business activities? Who makes other outsiders eligible to join your partnership, and what value is assigned to the stakes than partners hold in the venture in the event of exits or buyouts? Typically, partners are liable for the actions of other partners and must share profits and resolve conflicts.
Limited Partnership (LLP)
In these partnerships, each partner’s liability is limited in a proportion of his investment in the business. Input and control of management are also proportional to investment in the business. Service and real estate businesses often opt for these partnerships. Partner’s liability for debts is limited, depending on their role in management decision making. Setup of a limited partnership can be more expensive than other partnership types, and some partners in the partnership will be responsible for the business debt.
Limited Liability Company (LLC)
The LLC is available in most states and is a hybrid type of business permitting limited liability associated with a corporation and flexible features of partnerships. Forming an LLC can be complex, but advantages include than owners have limited responsibility for debts (even if they are in management) and business profits and losses can be assigned disproportionally to owner’s stakes in the business. LLC is simple for a sole proprietor to use, and to allow for flexibility about how the LLC pays its taxes.