The Best Business Structure for Your Small Business

This can be a long conversation or a short one. The primary subject of the conversation is liability and liability protection.

The short conversation is that almost all businesses can benefit from the protections offered by an LLC, at a minimal additional cost to owning a sole proprietorship or partnership. This is true even if you carry sole proprietor liability insurance. Read on for the long conversation.

 

Why LLCs are so popular

Limited Liability Companies (LLCs) are popular with small business owners because they offer the same liability protection as corporations, but without the complicated tax issues and maintenance requirements of a corporation. It’s the reason why almost all business owners can benefit by forming an LLC for their small business.

This is especially true now, because there are so many high quality LLC formation and maintenance web sites out there that can form an LLC for just a few hundred dollars. Because of their affordability and convenience, there is almost no reason to leave yourself exposed under a sole proprietorship or partnership.

You can use this guide to form an LLC on your own:

Step-by-Step LLC Guide

OR save yourself a headache and hire one of these reviewed services to do it for you:

LLC Formation service Reviews

Informal Business Structures (Sole Proprietors and Partnerships)

An informal business structure does not need to be formed. It comes into being as soon as you start selling a product or service. The two informal business structures are:

  • Sole Proprietorship
    A business operated by an individual without a formal structure. Sole proprietors file taxes under their own names.
  • Partnership
    An informally organized business owned by more than one person. Partnerships files taxes under the partners’ names and the partners are liable for any actions taken against the business.

Informal Business Structure Pros and Cons

Informal business structures Pros

The main benefit of an informal business structure over a formal one is how simple they are. As long as you acquire all the appropriate licenses, you can start doing business under your own name at any time. As a sole proprietor, you are your business and your business is you.

  • Simplicity
    There’s no difference between you and your business. Come tax time, you’ll simply report your businesses profits as income on your personal taxes.

Informal Business Structure Cons

Informal business structures do not separate the business owner from their business. This means if your business gets sued, your own personal assets could be on the line. That’s not ideal, and it’s easily avoided by forming an LLC.

  • Personal Liability
    No separation between business and personal assets.
  • Limited growth
    It’s difficult to add owners or partial ownership interest to an informal business structure. It can be more difficult to obtain financing and other forms of financing.
  • No tax benefits
    All profit from an informal business structure is taxed as income to the owner of the business in the year that it is earned. With formal business structures, you have more options as to how you pay taxes on your business’ profits.

Formal Business Structures (LLCs and Corporations)

A formal business structure is formed at the state level by filing paperwork with a state’s secretary of state. Unlike informal business structures, formal business structures create a legal separation between a person (or group of people) from their business. In the case of a formal business structure, a person’s business becomes its own legal entity.

  • Limited Liability Company (LLC)
    LLCs are designed to offer the liability benefits of a corporation, but without the complicated taxation and expensive maintenance of corporations. LLCs are owned by their members.
  • Corporations
    Corporations offer the same liability protection of an LLC, but require more complicated maintenance than an LLC. Accounting is more complicated with a corporation because revenue is taxed as corporate income, and then any income drawn from the corporation is taxed again as personal income. Corporations make it easy to receive outside investors because Corporations are owned by shareholders.

Formal Business Structure Pros and Cons

Formal Business Structure Pros

There are several reasons to choose a formal business structure over an informal one.

  • Liability Protection
    Protection of your personal assets against financial and legal claims made on your business.
  • Beneficial tax incentives
    Formal structures give you more flexibility as to how your business is taxed.
  • Credibility
    Formal business structures appear more professional to the general public
  • Financing
    Formal business structures are more enticing to investors and make adding owners and partial equity interests easier.

Formal Business Structure Cons

The main downside of a formal business structure is the cost of forming and maintaining them. In the case of an LLC, these costs are low, but they aren’t nothing.

  • Cost
    Formal business structures cost a few hundred dollars to form and a couple hundred dollars per year to maintain. It’s not much, but it is something.
  • Maintenance
    Formal business structures require annual reports to be filed in order to maintain status with the secretary of state. Though called reports, these are really just an annual tax that you must pay each year. The amount varies state to state, but range between $50 and a $300.