Starting a business in Colorado is an exciting prospect, but it also brings many decisions.
Whether it’s the fulfillment of a long-held dream or a recent opportunity that suddenly presented itself, you’ll want to make sure that you prepare yourself and your business for success.
Choosing the structure or type of business entity for your business is one of the most important and important decisions you will make.
It’s crucial to look at more than just the short-term picture: think about your long-term business plan and the financial implications it could have for you personally and for your business.
Here are some costly mistakes that all entrepreneurs should avoid when deciding how to structure a business.
Keeping business too casual
Maybe you are going into business with your childhood friend, a best friend, or a close family member. No matter how close and relaxed your relationship with them may be, don’t let go of your business deals. Keeping things too casual with other owners or partners can lead to the demise of your business, among other things.
Instead, formally document all agreements so that everyone is on the same page and there are no questions ultimately about what was agreed upon. Whatever business structure you agree to and any other deals you enter into, be sure to have them reviewed by a qualified lawyer and put them on paper.
Failure to form a legal entity
You can start a business without creating a legal person. However, it could drastically affect the financial future of your business. It is common for sole proprietors to start a business without filing a structure, but it is something that should be taken into account. Establishing a commercial legal entity offers many benefits to entrepreneurs, while abandoning a legal structure carries many risks, including:
Put your personal assets at stake: A legal business entity protects your assets that would otherwise be at risk in the event of financial hardship or litigation. You can protect your assets and keep things simple with a limited liability company (LLC).
Decreased Business Credibility: Consumers, sellers, and investors generally all prefer to do business with reputable and established companies. However, it is difficult to prove if you have not created a legal business entity. Starting a business as an LLC or corporation makes it easy to get a business bank account, business credit, EIN, etc. to establish that your business is trustworthy.
Ignore the tax implications
Business taxes can vary widely depending on the structure of the business. Weigh your options carefully. Understanding exactly what you will need to pay before determining what type of entity you want to create can help you avoid negative tax consequences. Not planning and researching the tax consequences for a business entity can be a costly mistake. Consider the following:
- Sole proprietors, partnerships and S bodies are allowed to benefit from passed on taxation. LLCs are not a tax type, but are taxed by default as a sole proprietorship or partnership. Consequently, LLCs are not subject to corporation tax; but owners will most likely have to pay self-employment taxes, typically around 15 percent of their profits.
- Limited liability company tax owners as sole proprietors or partnerships can potentially reduce the tax burden of their self-employment by filing as an S Corp using Form 2553. By paying a portion of the profits to owners in the form of wages / salaries and withholding taxes, perhaps we could lower the total taxes paid.
- While owners are also subject to double taxation, a C-Corp can be attractive depending on applicable tax rates and depreciation. For example, in the case of high investment companies, middle owners are taxed on ALL profits at regular tax rates before reinvestment. In comparison, the corporate tax rate for a C-Corp on profits could be much lower so that more profits can be reinvested. Therefore, later, the reinvested amounts not only increase the profits of the business, but when the owner receives the funds, they constitute capital gains and are taxed at a generally lower rate of appreciation instead of a ordinary income.
Bypass future growth
You might be on your own now, but do you expect or want your business to grow, possibly hiring partners or shareholders later? If you are hoping to find investors to support your business goals in the future, the entity you choose could play an important role in the future growth of your business. It could also have an impact on your bottom line. It is essential to understand the following elements regarding the structure and development of the company:
- Limitations on S Corp Ownership: S-Corps are not allowed to have more than 100 shareholders, and foreign owners are not allowed.
- Multiple LLC Members: Business owners have the right to add members to their LLC. However, they need to think about their role and their percentage of ownership. If the business folds or disagrees over how to operate the business, there could be significant financial implications.
- Property of C-Corp: In general, the structure of C-body allows for greater long-term growth. Yet they are also more complex and come under stricter regulatory and compliance standards.
Do not seek the help of a business lawyer
The best thing for a budding business owner to do is hire an experienced business lawyer. A knowledgeable lawyer can help them understand each business structure option as well as the advantages, disadvantages, and potential long-term costs of each.