One of the first decisions you’ll make as a business owners is how your business will be structured. You need to know the advantages and disadvantages of each of the different forms of business organization to make sure you make the right decision for your new business.
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All businesses must adopt some legal configuration that defines the rights and liabilities of participants in the business’s ownership, control, personal liability, lifespan and financial structure. The form of business determines which income tax return form to file and the company’s and owner’s legal liabilities.
This is a big decision that has long-term implications, so if you’re unsure of which form of business is best for your company, consult a professional. Luckily, there are several business counselors and centers across Kansas City offering free assistance in forming a business that are knowledgeable and ready to help.When you form your new business, account for the following:- Your (practical) vision regarding the size and nature of your business- The level of control you wish to have- The level of “structure” you are willing to deal with- The business’s vulnerability to lawsuits- Tax implications of the different organizational structures- Expected profit (or loss) of the business
Now let’s dig into the different forms of business organization.
The vast majority of small businesses start out as sole proprietorships. These businesses usually are owned by one person, aka the individual who has day-to-day responsibility for running the business. Sole proprietors can be independent contractors, freelancers or home-based businesses.
Sole proprietorship advantages
- The owner receives all profits.- Profits are taxed only once.- The owner makes all decisions and is in complete control of the company (but this could also be a disadvantage).- It is the easiest and least expensive form of ownership to organize.
Sole proprietorship disadvantages
- There is unlimited liability if anything happens in the business. Your personal assets are at risk (including your home in Kansas City).- It is limited in raising funds and the owner might have to acquire consumer loans.- There is no separate legal status.
Tip: When looking at setting up a sole proprietorship, assess what type of liability you have. If you’re selling advice or services, you may need an errors and omissions insurance policy to cover yourself against claims for negligence. Determine what you have to lose. Do you own a home or savings account? Your personal assets could be at risk in the case of a lawsuit.
In a partnership, two or more people share ownership of a single business. Like proprietorships, the law does not distinguish between the business and its owners. The partners should have a legal agreement that establishes how decisions will be made, how profits will be shared, how disputes will be resolved, how future partners will be admitted to the partnership, how partners can be bought out or what steps will be taken to dissolve the partnership when needed.
Disclaimer: If you’re establishing a partnership, it is extremely important to make sure everything is outlined in case things go sour, especially when starting a business with a loved one or friend. Seek legal advice to create a partnership operating agreement to hash out all business decision possibilities, including succession or exit plans. Several legal services in Kansas City are ready to help you every step of the way.
- It is easy to establish (with the exception of developing a partnership agreement).- Separate legal status gives liability protection.- Profits are taxed only once.- Partners may have complementary skills.
- Partners are jointly and individually liable for other partners’ actions.- Profits must be shared with the partners.- Decision making is divided.- Business can suffer if the detailed partnership agreement is not in place.
A corporation is considered by law to be a unique entity, separate from those who own it. A corporation can be taxed, sued and enter into contractual agreements. The corporation has a life of its own and does not dissolve when ownership changes.
There are three types of corporations: C-corporation, S-corporation and Limited Liability Company.
A C-corporation is a corporation that is taxed separately from its owners. It gives the owners limited liability, which can encourage more risk-taking and potential investment.
- It is limited liability.- In regards to transfer of ownership, shareholders can sell their shares.- Capital is easier to raise through the sale of stock.- The company pays fringe benefits.- There are tax benefits.
- It is subject to double taxation. (Corporation and shareholder earnings are taxed.)- It can be costly to form.- There are more administrative duties. This entity type is required by law to have annual meetings, notify stockholders of the meeting and keep minutes of meetings.- C-corps pay corporate taxes at a different time than other forms of business.
An S-corporation, also known as subchapter S-corporation, offers the owners limited liability. S-corporations do not pay income taxes; the earnings and profits are treated as distributions. The shareholders must report their income on individual income tax returns.
- It enjoys limited liability.- It avoids double taxation.- Profits are taxed only once.- Capital is easier to raise through the sale of stock.- It offers transfer of ownership.
- It can be costly to form.- Stockholders are limited to individuals, estates or trustees.- It is subject to required administrative duties.- It cannot provide company paid fringe benefits.- Stockholders are limited to citizens or resident aliens of the United States.
Limited Liability Company
A limited liability company or LLC is a hybrid business structure that provides the limited legal liability of a corporation and the operational flexibility of a partnership or sole proprietorship. However, the formation is more complex and formal than that of a general partnership.
Tip: Forming an LLC requires the business owner to file legal paperwork. You may want to consult an attorney to help you with the process. Here is a list of service providers in Kansas City that provide legal assistance.
Limited liability company advantages
- It is the most common business structure and is specifically created for small businesses.- This entity type requires insurance in case of a suit.- It is a separate legal entity.- LLCs are usually taxed as a sole proprietorship.- LLCs can have an unlimited number of owners.
Limited liability company disadvantages
- It can be costly to form.- It requires yearly administrative costs.- LLCs have a personal tax liability.- Legal and accounting assistance is recommended for LLCs.
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Who can help?
Many business-building organizations in Missouri offer legal services to help you through these beginning stages of launching your business. Start with this list or pop over to The Resource Navigator to filter this list by your location, industry and more.