Once you have a great business plan and a catchy name, it’s time to start registering your company. No matter what kind of business you’re running, you must register formally as a legal entity for tax, liability, and organizational purposes.
New owners are often perplexed by the varying legal structures their businesses can assume. With so many different options, the confusion is understandable.
To find the most suitable option, you have to understand each potential legal structure’s main characteristics, its pros and cons, and how these factors impact your business’s needs.
The legal structure you choose factors into your business’s ownership type, the taxes you pay, and your personal liability. We’ve outlined some of the most common legal structures to help you better understand which model will work best for your business.
Here’s what you’ll learn in this guide:
- The factors you should use to determine the right legal structure for your business
- The different kinds of legal structures for businesses
- The pros and cons of each legal structure
What Should You Consider When Selecting a Legal Structure?
- The size of your company
- The startup cost for your business
- Your potential legal liability
- The type of taxes your business should pay
There’s no one-size-fits-all approach to selecting a legal structure. However, there are several factors to consider in determining the appropriate legal structure for your business.
The needs and goals of your business will determine which legal entity is most appropriate. But, it’s not enough to copy what similar companies are doing. You need to look at your business’s overall functioning and how you want it to look in the future.
What is the Size of Your Business?
The number of people involved in your business can give you a clear idea of the ideal legal structure. If you’re operating solo, you can avoid a lot of legal fees and complicated paperwork by starting a sole proprietorship.
However, if you’re employing an entire team, you might be interested in the legal protection of more sophisticated options.
Be warned: You’ll end up paying costly fees (or even just more in taxes) if you choose a legal structure that is too large or too small for your business.
How Much Do You Have to Invest in Your Business’s Start-Up Costs?
There are hidden costs involved in starting any business — and many show up when you start legally registering your company. That includes application fees, insurance premiums, and potential licensing costs.
When choosing a legal structure, think about how much it’ll cost to get started. Whether you’re starting a brick and mortar store or an eCommerce website, your expenses will vary depending on your business’s legal entity status.
What Kind of Liability Protection Do You Want?
Opening a business makes you far more vulnerable to legal action than when you were an employee. Anyone who sells goods or services is partially liable for any negative effects these items have on clients.
The kind of legal structure you choose determines your liability. Some legal structures put your personal assets and income at risk. Others offer personal protection, but use your business as a bulwark against legal action. If you know what kind of coverage you need, it will be easier to determine the right legal structure for your business.
How Should Your Business Be Taxed?
Taxes are one of the primary reasons state and local governments require businesses to legally register. Each type of legal business entity is taxed differently.
If you pick the wrong structure, you might end up in legal trouble with government tax agencies. Alternatively, you may wind up paying more than you need to. If you understand how your business should be taxed, it will be easier to ensure your bookkeeping is accurate, and know that you’re on the right side of the law.
What Kinds of Legal Structures Can Your Business Have?
The most common legal structures for businesses are:
- Sole proprietorship
- Limited liability company (LLC)
Let’s compare a few of these options.
Sole Proprietor vs LLC
Limited liability corporations (LLC) and sole proprietorships are the most common types of legal structures. This is due to their ease of establishment and the vast majority of businesses falling into one of these two categories.
So, which wins out between sole proprietor vs LLC?
Let’s take a look at some differences between the two.
In general, a sole proprietorship is the most straightforward option and quicker to set up. The paperwork required to get started is minimal. However, this simplicity comes with certain limitations.
When considering the tax and legal advantages of a sole proprietor vs LLC structure, the LLC wins. Although it’s easy to get going as a sole proprietor, your personal taxes and expenses are attached to your business, leaving you completely open to potential legal issues.
If you plan to hire employees, you don’t even have to decide between a sole proprietor vs LLC — sole proprietors can’t legally employ anyone.
LLC vs Partnership
If at least two people are entering into business together, it’s automatically considered a partnership. No formal paperwork needs to be completed.
Alternatively, to form an LLC, owners have to file a certificate of organization within their state.
Within a partnership, both individuals are personally liable for all associated business debts. However, an LLC (or an LLP in this case) is a unique, hybrid legal structure. You get the tax perks of a partnership while receiving a corporation’s liability protection. When you own an LLC, you’re protected from personal liability for company problems.
Neither partnerships nor LLCs pay taxes directly. Instead, all losses and income are reported on the owners’ tax returns.
What’s the Difference Between a Partnership vs Corporation?
Size and complexity are the main differences between a partnership and a corporation.
Partnerships involve at least two people who share ownership in the company while a corporation shares ownership amongst a number of shareholders.
The advantage of bringing on shareholders is the additional capital they bring to your business. These individuals act like distant owners who invest in the company without taking much of an active role in operating it. The downside to a corporation is that those shareholders do have a say in how things are run.
In a partnership, owners only have to answer to each other. It’s a simple management system that will run as smoothly as the relationship you have with your partner — so choose wisely.
Another important difference between a partnership and a corporation is startup time and costs. It takes more time, paperwork, and investment to start a corporation. This time-consuming process also eats up more of your financial resources.
Setting up a partnership, on the other hand, is a little bit easier and a more straightforward process. That said, the specific steps you need to take to get started will depend on the type of partnership you choose.
What’s the Best Legal Structure for Online Business Ventures?
If you’re starting an online business by yourself, there’s a good chance your choice will boil down to sole proprietor vs LLC. These are the most basic business structures for a single individual to launch.
When it comes to overall startup fees for sole proprietor vs LLC, the former wins by a thin margin.
On average, an LLC will take a few hundred dollars to start, but a sole proprietorship is entirely free. You might end up spending around a hundred dollars to register a doing business as (DBA) name, but the overall cost is still considerably less.
If you’re looking for optimum legal protection when considering sole proprietor vs LLC, you should go with the latter. The advantage is right there in the name: limited liability corporation. While your business will still have to answer for any debts or legal fees, your personal expenses and assets are spared.
If you’re stuck choosing between filing as a sole proprietor vs LLC, it’s always a good idea to err on the side of caution and invest in greater security.
An LLC will protect your personal assets from any legal action that might result from the selling of your services or products. This option also offers you greater flexibility when it comes to hiring help as your business grows, which is your ultimate goal.
In the sole proprietor vs LLC debate, there are some cases where the sole proprietor structure wins out. But, the advantages of an LLC are tough to beat.
Choosing the right legal structure is a fundamental part of starting a new business. It determines the length of the setup process, the expenses involved, how you’ll pay taxes, and the overall organization of your business.
Taking the time to ensure you’ve chosen the correct legal structure for your company can help you avoid unnecessary fees, bypass legal issues, and maximize efficiency. Start by clearly defining your company’s needs and then consider each business entity’s pros and cons to find your best match.
You can always restructure in the future as your business grows and changes. While you might be considering a sole proprietor vs LLC structure initially, you might be choosing between a corporation vs partnership in a few years.
Once you’ve determined your company’s legal structure, get the ball rolling on building your business by creating a website. Bluehost has the resources and tools to help you get started. Check out Bluehost’s web hosting plans today.