8 min read

How to Choose the Best Legal Structure for Your USA Business


Amanda Sciara
Business Specialist
Contributor
Usa Business legal structure
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So, you decided to go into business for yourself? Great! There are many things to consider when it comes to your business, and many things will be determined based on the organizational structure that you will use. Four major types of organizations that we will discuss today are sole proprietorships, partnerships, corporations, and LLCs (Limited Liability Companies); they each have different requirements, costs, benefits and drawbacks. As with anything in the business world, understanding what is available to you and how to navigate different options will give you the best start in your new endeavor. The requirements for each of these will vary from state to state. Your local secretary of state will have information on what is required for each type of business in your area.

Sole Proprietorship

This is the easiest type of business structure to legally establish. This type of business is owned by one person, and there is no distinction between the individual and the business. Also the cheapest to form, sole proprietorships are the most common type of business structure. Many people actually operate as sole proprietors without even knowing it; freelance writers operate as sole proprietors. Most small businesses start out as sole proprietorships. As business increases, operations grow, and as more people become involved, the business owner may choose to restructure to a different type.

The sole proprietorship will operate under the name of the owner unless a doing business as (DBA) name is registered. The name must be unique; it will be rejected if another business in your home state already operates under the same name. Check with your state or county; they will have a searchable database for business owners to see if their DBA name is available. Once the sole proprietor registers a DBA name and obtains the proper local licenses, he/she is ready for business!

There are pros and cons to this type of business structure.  Of course, its simplicity is a huge benefit. There is so much to do when starting a business; you will literally be pulled in a million directions at once! Anything that can be done without a mountain of paperwork is desirable. There are no partners vying for control of the cash flow or trying to make their own decisions.  As the Sole Proprietor, you control all of the cash and make all business decisions. For a small business that has control concentrated with one individual, changes and corrections can be made quickly and more effectively. No matter how prepared you are for your endeavor, there will no doubt be much trial and error when business operations commence. Being able to react quickly to market analysis and new information helps this type of business structure stay competitive with companies who have been around much longer. Taxes for this type of business are very simple as well. Business income is personal income because the business and the individual are one in the same. For somebody starting a business venture for the first time, this is a good way to get your feet wet. Taxes can be a headache for one who doesn't have experience with different tax structures or who has limited time to devote to studying tax law.

For all the positives of this type of structure, the cons carry some weight, as well.  Most importantly, the owner is personally liable for all debts and obligations.  The buck stops with you so take care not to get in over your head. Personal assets such as bank accounts, equipment, even someone’s home and car are at risk if loans are unable to be repaid. If the business is involved in an accident or any type of negligence, the owner can be personally responsible- once again all personal property is at risk. The death or impairment of the owner can and usually does result in the end of business operations and the business itself. Also, sole proprietorships don't seem as impressive to potential investors, and it's hard to raise capital when assets are limited.

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Partnership

Ownership in a partnership is shared between two or more people. It is imperative to know your partner(s) well and make sure legal documents are in place regarding profit division, decision making processes, buy-out agreements, bringing in new partners, business expansion and anything else that is important to any of the parties involved. These legal documents aren't needed, but I strongly recommend that they are in place before any business operations occur. Partnerships can be harder to dissolve than marriages, and, unfortunately, money and power can bring out the worst in people - even those who we personally know. Forming a partnership is very much like forming a sole proprietorship. You must register your business with local agencies, select a DBA name, and obtain local licenses required for your specific business.

Partnerships can be a great structure because there are different individuals with complementary skills. You don't have to personally know how to do everything. Responsibility is shared; assets are increased. This structure is cheap and easy to set up. However, there is still unlimited liability; and you are liable not only for yourself, but for your partner(s) as well. This is why it is very important to know those who you plan to do business with. Shared profits means that each partner will want to make sure that their cut is fair given the time, energy, and resources they put into the business.

Corporation

A corporation is a completely different legal structure. The company and the owner are separate entities. The corporation is legally recognized as an individual, with the same rights and responsibilities. This means that the corporation may take out loans, legal action may be taken against the corporation rather than the owner; the corporation may also take legal action on its own behalf. This gives the personal assets of the owner tremendous protection. Most large companies are corporations, even if restructured from one of the more simple forms mentioned prior. Larger companies have larger liabilities, and smart business people are always on the lookout for how to reduce their risk. The requirements to form a corporation vary from state to state; your local secretary of state can help you understand what is required in your area.

The most attractive aspect of incorporation is limited personal liability. Because any legal action taken against the company will be taken against the corporation and not against the individual owner, more stability is a given with this type of business. Also, it is easier to secure loans and to get the attention of investors because a corporation will have more assets and will appear more professional than the previous two structures outlined. Roles within the business are clearly defined; who makes what type of decisions is spelled out in the company guidelines and articles of incorporation. Common stock may also be released to the public through an IPO (initial public offering), securing more funding for its operations. A corporation that chooses to release shares of common stock may use shares of company stock to attract and keep quality employees. However, time and cost can be prohibitive to setting up this type of business. Taxes are very complex and profits may be taxed twice. The company pays taxes on profits, and the shareholders pay taxes on their income (which comes from the profits that were already taxed). There are many company procedures to follow. The founder is often not able to make decisions alone; responsibility and reward are spread out among directors and operators.

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Limited Liability Company (LLC)

A limited liability company combines the ease of operations and simplified tax structures that sole proprietorships and partnerships enjoy with aspects of a corporation that limit the owner's liability. Setting up an LLC is a bit more complicated and costly than setting up a sole proprietorship or a partnership. Again, legal requirements vary by state, so check with your local officials as to what is required. Most LLCs must file articles of incorporation with the state in which they operate in, and it is recommended that an operating agreement be put into place so that roles, profit sharing, etc. between members is clearly understood by all involved parties. Although limited liability and ease of profit sharing make this type of business very attractive, there are other aspects to consider. Because LLCs are structured more like sole proprietorships and partnerships, if the owner or one of the owners dies or is incapacitated many states will end business operations. Check with your state to see if you can add a clause into the operating agreement regarding the continuation of business activities if something happens to one of the owners. Members of the LLC are considered self-employed. Net income is therefore subject to self-employment taxes.

Whatever type of organizational structure you ultimately decide upon, your local secretary of state will have the information and requirements needed in order to get your company started. This first step is arguably one of the most important business decisions that you will make; take time to fully understand your options and what will work best with your chosen area of business. 


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Amanda Sciara Business Specialist
I grew up working in a small family business; my brain is just wired to work this way. As a young mother, I am looking to make a name for myself and am in the first stages of opening my own business. I am so looking forward to the challenges and rewards of getting a business off the ground, and I think that you would love to follow me along on my journey!
I grew up working in a small family business; my brain is just wired to work this way. As a young mother, I am looking to make a name for myself and am in the first stages of opening my own business. I am so looking forward to the challenges and rewards of getting a business off the ground, and I think that you would love to follow me along on my journey!

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