Running a successful business is no easy task. Statistics show that more than half of all startups will fail by their fifth year. Unfortunately, many entrepreneurs neglect to set up the proper business entities for their commercial endeavors, forcing them to pay more taxes and do more paperwork while placing their personal assets liable to civil lawsuits.
The most basic legal structure for a business is a sole proprietorship. If you sell a product or service to the public for commercial purposes, and you haven't set up a legal entity, your business is considered to be a sole proprietorship. Aside from obtaining a local business license, there's virtually no setup required for this structure, making it an attractive choice for aspiring entrepreneurs. But sole proprietorships offer no protection of personal assets for business-related obligations, meaning a disgruntled customer could sue you for the money in your personal bank account.
In a general partnership, two or more entrepreneurs agree to launch a business together, either verbally or in writing. It's similar to a sole proprietorship in the sense that partnerships only require a local business license to operate, and there's no protection of personal assets with this type of entity. Taxation for both sole proprietorship and partnerships is done on a personal level.
Limited Liability Company
Limited liability companies (LLCs) have become an increasingly popular business structure in recent years, and for good reason: they are easier to form than a corporation and offer protection of personal assets for business-related obligations. Furthermore, it's easier to obtain funding for an LLC as opposed to a sole proprietorship or partnership.
Note: LLCs can be formed with just one person in all 50 states now.
Although they require a greater amount of paperwork to set up and maintain, corporations have certain benefits that shouldn't be overlooked. The courts view corporations as being separate legal owners, meaning the corporation can be sued, but not necessarily its owner(s). There are exceptions to this rule, however, such as cases in which the plaintiff can “pierce the corporate veil” by proving that the owner, officer or director conducted fraud, failed to separate his or her personal assets from that of the corporation, or other reasons.
Be warned, though, corporations can be taxed more heavily than the aforementioned business entities. For this reason, there are different types of corporations to consider. A C-Corp, for example, can be taxed as high as 35%. An S-Corp, however, is bit more forgiving since it avoids double taxation.
So, which legal structure is right for your business? Being that no two businesses are the same, there's no easy answer to this question. Entrepreneurs and business owners should consult with a lawyer and accountant to learn more about the entity that is right for their business.