One of the first tasks of a startup is to establish a legal corporate structure based on the entity’s goals and federal, state and local regulations. While a company can change its structure to accommodate growth, the initial decision can influence taxes, control of operations, and the personal liability of its owners.
1. Sole Proprietorship
A sole proprietorship is owned and managed by one person, and the fees are generally minimal. The owner files business taxes with his or her individual return and may qualify for certain operational expense deductions. SPs are easy to form and easy to dissolve without filing official paperwork with the state. However, the law holds the owner personally and financially responsible for everything the company does.
Similar to sole proprietorships, partnerships have two owners that share control, profits, and liabilities. Partnerships offer a lot of flexibility as the owners answer only to each other but carry extra risk since each partner is liable for anything the other does. Certain partnership structures allow one partner to control the company, while the other receives profits and plays a role as defined by a partnership agreement.
A corporation is an independent entity, and there are numerous subclassifications within this corporate structure. Individuals or other businesses hold and transfer ownership in the form of stock certificates. The percentage of stock held by one or a group of owners usually determines who controls the company. A corporation files taxes separately from its stockholders, who receive income through salaries, bonuses and dividends. In turn, it shields its owners from personal and financial liability for the company’s actions.
4. Limited Liability Company
Limited liability companies fall somewhere between partnerships and corporations. Like partners, LLC owners can claim the company’s profits directly as income on their personal tax returns, avoiding the setup and maintenance of establishing structured salaries. Like corporate stockholders, their assets are protected from seizure to pay business debts. However, this protection disappears if a court proves that the owners conducted business negligently, unethically or illegally.
A cooperative is a business structure that is, in essence, owned by its patrons. For example, an outdoor sporting goods store that offers a membership to its customers for a one-time fee in exchange for discounts, benefits and voting rights is a co-op. Co-ops have a lot of leverage and sometimes qualify for federal startup grants, but they are also legally complex and complicated to form.
A basic understanding of the options can aid entrepreneurs in selecting a corporate structure. Still, it is usually wise to seek professional advice to make sure they make the best choice.