What is the Best Legal Structure for Your Business?

A business can be organized as a sole proprietorship, a general partnership, a limited partnership, an LLC, a “C” corporation or an “S” corporation.  Each type of organization has its own advantages and disadvantages.  Note that as each state has its own tax structure, the focus of this article is on federal-level taxes only.

There are four main factors to consider when an entrepreneur decides on the form of organization that best fits their business:

• Taxes
• Limitation of personal liability
• Ease of transferability
• Admission of new owners and investor expectations

It is typically recommended that a founder form a business first as a limited liability company (LLC) and then plan to convert it to a C corporation immediately, before taking institutional investment, which is typically money from a venture capital firm.

A sole proprietor can use their social security number and need not apply for a federal taxpayer identification number.  Tax reporting is easy: simply report the company’s income and expenses on a form (Schedule C) that the founder will attach to their annual tax return.

A general partnership is easy to form and operate, however, it also provides no liability protection for the partners; each general partner is completely liable for the debts of the partnership.

A corporation can provide protection to a founder against the liabilities of the company.  If managed properly by setting up a separate corporate bank account, not paying personal expenses through the corporation, and having the corporation’s board of directors authorize certain corporate actions, the corporation can protect the founder. 

A limited liability company (LLC) provides the limited liability protection of a corporation, while avoiding the double taxation.  Because it is taxed like a partnership, it can be more flexible than a corporation.

It’s best to consult with your attorney and your accountant to decide on the form of organization that best fits your individual needs.

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