When you start a new business one of the first things you must decide is how you will structure your business. The structure you select depends on a variety of factors: the type of business you will be conducting, the business' need for funding, the level of investor participation you'll accept, legal and organizational expenses involved in setting up and other tax issues.
Some of the basic types of business structures you will consider are:
- Sole proprietorship
- Limited partnership
- Limited liability company LLC
- C- corporation
- S- corporation
- Non profit corporation (not-for-profit)
Step 1: Develop a Business Plan
During the business planning process, you will look at which type of business structure best fits with the type of business you are setting up. If you're on your own and funding the startup yourself, a sole proprietorship may be the most practical. If you have partners in the venture, some kind of partnership may be best. If you have assets to protect, incorporating may be the wisest course. If you're creating a charitable organization, a nonprofit may be best. Co-ops are a better structure for customer-owned endeavors like shared water systems, markets or other utilities. Take these steps during your business planning process to help you select the best business structure for your enterprise.
Step 2: Analyze your Potential Liabilities
Different business startups will require different levels of funding. Decide what level of risk you are willing to accept. Generally, the higher the level of risk associated with your business, the thicker the layer of protection you want between your personal assets and those of the business. Beware, however, there are tradeoffs. The more protection for your personal assets your business structure grants you, the less control you will have over the business. In a corporate structure or limited liability partnership it is entirely possible for you to find yourself answering to investors or partners and having little real control over the business you created. Far better to decide these issues after a cold analysis of each type of business structure before you establish your company. In the end, you may decide on a progressive plan that moves from a more nimble sole proprietorship in the early days of the company to a partnership, corporation or LLC structure that spreads the risk and protects any personal assets you may have built up.
Step 3: Research the Paperwork
The various structures each demand different levels of expenses during the startup phase or during a transition to a different structure. While sole proprietorships require little in the way of legal filings and fees, creating a partnership or corporation may involve legal fees, state filing fees and expensive accounting procedures. Some corporate structures require annual reports, additional tax filings, fees and licenses. Some structures like C-corporations and S-corporations for instance, have different rules and tax advantages for things like fringe benefits and retirement planning. Such advantages may prove important to you and your employees. At the same time, corporations are notoriously paperwork intensive for all their advantages. Knowing what you will be getting into paperwork-wise, may greatly influence your choice of a business structure.
Step 4: Know the Tax Requirements
Familiarize yourself with the types of tax filings required for each structure you are considering. Know what accounting demands the structure will place on your bookkeeping system. Will the double taxation common with incorporation raise or lower your take home profits? Even nonprofit corporations can be required to conduct annual audits and submit complex tax reports. Your accountant can talk with you about the costs and accounting demands of the various business structures you are considering.
Step 5: Understand Your Business’s Investment Needs
Every new business requires capital. A careful consideration of how much it will cost you to get your project up and running will suggest what sort of investment you'll need to make. As a sole-proprietor you will be responsible for all the investment costs for your business. For endeavors that cost more, you may need to add partners or investors who will then share profits. Partnerships may serve to spread the costs and share the profits equitably. For a more complex and expensive business model with changing investors and varying levels of participation, incorporation with a stockholder structure may best serve to keep funding flexible enough to meet your needs.
Too often entrepreneurs don't consider which structure will best suit the nature of their business. Too often they worry that a business plan will hamper their spontaneity or flexibility. The truth is, that need for flexibility and responsiveness suggests the type of business structure the new enterprise should adopt. Don't just pick a business structure off the shelf based on what everyone else is doing. Develop a thorough business plan and select a business structure that supports what you want your business to do.
Nolo Business Encyclopedia: Choosing the Best Ownership Structure for Your Business
FindLaw: Business Structures – Which One is Best for Your Business
Intuit: Selecting an Ownership Structure for Your Small Business
Financial Planning Perspectives: Choosing a Small Business Structure