When you start your own business, you need more than a good idea. How you choose to build your business can be crucial for long term success. There are a variety of considerations when looking to structure your new business and decide between Sole Proprietorship, S-Corp, C-Corp, or LLC. Each option has its own advantages and disadvantages which must be taken into account in the decision-making process.
Below, we outline the important issues that should be considered when starting your business and their impact on choosing how to structure your business.
Cost of training / operation
While the cost of registration is very similar regardless of which option you choose, each structure has a different level of cost to train and maintain. A sole proprietorship is the cheapest and easiest structure not only to form, but also to maintain and operate. This makes it the most common choice.
A company will cost more to train and operate, but still offers a relatively low start-up cost. An LLC is the most expensive option to operate due to the cost of compliance.
While start-up and operating costs are significant, they cannot be the only factor in the decision.
Legal liability is one of the most important issues to consider when choosing a business structure. Your personal liability depends on the structure you choose, so you should assess the level of risk associated with the business and the protection offered by each structure.
A sole proprietorship does not offer liability protection, so if the level of risk with the business is determined to be high, this is probably not the best option.
An S-Corp or C-Corp offers much more protection to shareholders, and an LLC offers the highest level of liability protection to owners, also known as members.
The tax implications of a business structure can be complex, and you should fully understand what they are for each option.
A sole proprietorship is not a separate legal entity from the owner, which means that the income from the business goes directly into the owner’s personal income tax return. There is no separate tax return for the business.
Corporations and LLCs are flow-through entities, so the income of the business is passed on to shareholders or members. It also eliminates the separate business income tax.
For a C-Corp, there are taxes at the entity and shareholder level, but for an S-Corp, there is usually no federal income tax at the entity level.
For S-Corps and LLCs, income is taxed at the shareholder or member level regardless of cash distributions.
There are a few more points of differentiation between an S-Corp, C-Corp or LLC.
All these options allow companies to offer share grants to employees; however, stock awards must be structured differently for an LLC and can be more complex.
An S-Corp is limited to the issuance of a single class of shares. They cannot issue preferred shares to shareholders. They are also limited in number and type of shareholders. S-Corps cannot have more than 100 shareholders and they must be individuals, estates or qualifying trusts.
An LLC offers more flexibility with respect to the number of members and can issue multiple classes of shares.
An LLC can be more difficult to find investors because of the tax and regulatory issues associated with the structure. You may also need to convert to a company afterwards if you are considering an IPO.
Deciding on the structure of your business is a very complex question. Legal and tax advice along the way is essential in making the right decision for you and your business.