By "type of business," I don't mean what products they should sell or whether they should be a manufacturing or service company. No, we were debating which legal form their business should take.
When you've got so much other stuff to worry about, why even bother dealing with your "corporate form." After all, if you're going to be a consultant, a graphic designer, or an electrical contractor, why spend more money on legal or corporation fees?
But choosing a legal form affects how much you pay in taxes, who can invest in your company, and most importantly, your personal financial security.
Three things to keep in mind when choosing a legal form are:
•Liability: Legally, corporations (and limited liability companies – or LLCs) are individual entities. As such, the corporation – not individual shareholders – are responsible for the actions of the business. In other words, if something goes very wrong and a corporation is sued, only the assets of the corporation, not the owner's personal assets — are at stake. There are some exceptions to this rule, but generally, your personal liability is GREATLY limited.
•Double taxation: No one likes paying taxes even once, so you certainly don't like paying taxes twice – once on income for the business and then again when that income is distributed as profits to you. That's why most businesspeople choose a legal form that allows for the profits of the company to "pass through" to the owners, without having to pay corporate taxes first.
•Ownership: Certain legal business forms limit the number or type of people who can invest in your company. If you're seeking a large number of investors or international investors, find a corporate structure that permits such stock holders.
It's always best to sit down with an attorney – and possibly an accountant — and discuss the best corporate structure for your specific business and circumstance. And state corporation laws differ.
When you do meet with an attorney, these are the legal structures you'll consider:
•Sole Proprietorship: A business owned by one person with no formal legal structure.
Advantages: It's simple! Just start your business; there's no additional paperwork. You don't file corporate income taxes – just a Schedule "C" with your personal income taxes.
Disadvantages: You have no personal liability protection. If your business is sued, you could lose everything you own – and in some cases, your spouse could lose his or her assets also.
•Partnership: A business with more than one owner who actively engages in the management of the company.
Advantages: No required legal forms (although you'd be well advised to draw up a partnership agreement). No double taxation – profits pass through to the partners.
Disadvantages: Each partner has unlimited personal liability, even for actions taken by other partners. Be warned: if you go into business with others, you've got a partnership in the eyes of the law whether or not you've drawn up any paperwork.
•Limited Liability Company (LLC): A legal form providing liability for company's owners without incorporation. LLCs have become the form of choice for many small companies.
Advantages: Personal liability protection for owners and pass through profits without corporate taxes. Profits can be distributed unequally – a 60% shareholder can take only 10% of the profits – allowing more flexibility for tax planning.
Disadvantages: LLC laws vary by state, but you're likely to be limited in how many investors (owners) you can have and you may not be able to have international investors.
• "S" Corporation: A type of corporation provides personal liability protection for owners with pass-through taxation (rather than double taxation).
Advantages: Before the creation of LLCs, the form of choice for small companies; lawyers and accountants are familiar with laws relating to S corporations.
Disadvantages: You can't distribute profits unevenly as you can with LLCs and pay state corporate fees.
• "C" Corporation: A corporate form that allows for the most investors (including foreign investors) and significant liability protection.
Advantages: No limit to the number of people who can own stock. This is the legal form for companies that intend to be publicly traded.
Disadvantage: Double taxation.
Rhonda Abrams is author of Trade Show In A Day and president of The Planning Shop, publishers of books and other tools for business plans. Register for Rhonda's free business planning newsletter at www.PlanningShop.com. For an index of her columns, click here. Copyright Rhonda Abrams 2007.
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