What's the Best Legal Structure for My Small Business?

This is among the most frequently asked questions when planning a new small business start-up. It's also one of the most important ones to answer. The structure you choose will affect everything from paying taxes to assigning liability, from raising capital to sharing profits.

Each type of structure has trade-offs that should be fully understood. Here's a quick comparison of the most frequently used by small businesses:

A sole proprietorship is an unincorporated business owned by one person. Paying taxes is relatively simple, as the owner reports income/losses along with his/her personal taxes. However, the owner is personally liable for any business-related expenses or liabilities. While there are no corporate registration requirements, sole proprietors may still have to comply with local registration and licensing laws.

In a partnership, two or more people share ownership. Each contributes time, resources, expertise, and/or money to the business in return for a share of the profits/losses. Each partner is also responsible for his/her own actions, as well as business debts and decisions made by other partners. That's why a partnership agreement is a must. It should detail each participant's contributions and responsibilities, division of profits, resolution of disputes, and the handling of other major business decisions.

Then there's the corporation, an independent legal entity owned by shareholders. Corporations inherently have complex administrative, tax, and legal requirements. On the other hand, selling various types of shares in an established business can make it easier to raise capital. Plus, shareholders are not legally liable for the business's actions and debts.

A variation of this structure is the "S Corporation," named for the Internal Revenue Service subchapter that defines it, and often used in situations where the shareholders are also employees. An S Corporation distinguishes between shareholder/employee wages and other profit distributions, which are taxed at different rates. However, S Corporations carry the same legal and administrative requirements of "regular" corporations.

The limited liability company (LLC), has become a popular structure for small businesses in recent years. LLCs offer a corporation's limited liability with a partnership's flexibility and simplified taxation. There are also fewer record-keeping requirements, and it's entirely up to the LLC's owners (known officially as "members") to determine profit distribution. However, LLC members must pay self-employment taxes and make their own Medicare and Social Security contributions. When a member leaves, the LLC must be dissolved.

In case you are wondering, my companies have always been structured as a social purpose corporation. Go ahead and do your research, but my companies always give back and are defined by the social purpose of building or strengthening a sector of industry. That has always proven to be a winning strategy personally.

Each structure has provisions and options that require exploration before finding the right match for a small business. And the best place to get help with this decision--and any other small business issue--is affiliated with the SBA or your local attorney and tax specialist.

Get Busy. Sprout & Grow.

P. Simon Mahler, nominated as both an 'Expert' and 'Leader' Influencer in North America for small business, currently volunteers for both the SCORE organization as part of the "Mentors to America's Small Business" and for Startup Grind Boise. Dedicated to building stronger economies in small communities and helping small businesses succeed through educational entrepreneurship, Simon is committed to the future success of each and every small business in small towns across the country. He is always available to take calls for action and is willing to mentor to any small business out there across the globe. Follow him on the journey of his next endeavor, by starting a business of your own. His daily blog of activities will be posted on LinkedIn for you to enjoy. Find him on social media and connect to get some great ideas to get your business growing!

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