When forming a business, the type of legal entity you choose will determine the formation process as well as the way the business is run. Here, we’ll go over some of the most common legal entities along with their strengths and weaknesses.
In a sole proprietorship, you and the business are one entity. As such, you bear full liability for everything you do in your business. On the upside, there is very little in the way of formal business requirements or legal costs when forming one since you don’t need to register a sole proprietorship.
Sole proprietorships are great if:
- You are the sole owner of the business
- You have minimal business expenses and tax liability
They’re not so great if:
- Your business operations make it likely that you’ll get sued
- Your main purpose is growth
In a limited liability company (LLC), the business is a separate entity from the owners, meaning you are not personally liable for business operations. LLC’s also have fewer requirements than S-Corps or C-Corps, making them highly flexible. Unlike a sole proprietorship, they must be registered and have rules set up.
An LLC is a great choice if you:
- Are likely to get sued
- Have minimal tax burdens
- Want to start simple
- Have owners based outside the U.S.
On the other hand, an LLC won’t help you much if you:
- Want to invest into the company
- Hope to get crowdfunding, investment funds, etc.
- Plan to issue equity to your employees
In an S-Corp, the main advantage comes in that it is considered a pass-through entity—in other words, the company’s profits and losses are passed through to the shareholders. This prevents double taxation, or taxation at both the corporate and at the personal level.
In order to qualify as an S-Corp, however, a company must meet certain requirements:
- No more than 100 shareholders
- All shareholders are U.S. residents
- The company only has one class of stock
- All the shareholders are individuals, trusts, or estates
An S-corporation is your best choice if you:
- Operate only in the U.S.
- Hope to minimize personal liability
- Intend to keep things small
- Want to minimize your tax burden
- Don’t want to wait five years to go public
- Don’t need investment funds
On the other hand, don’t go with an S-Corp if you:
- Want to rely on investment or crowdfunding
- Hope to issue equity toward employees
- Don’t meet the requirements listed above
A C-Corp is a fully independent entity, so the owners have minimal liability for its operations. It also has the most flexibility in terms of size, growth, and ownership, but it also has the most legal and registration requirements to keep up with. Also, these entities are subject to double taxation, meaning they will be taxed on the corporate level and then again on the personal level.
A C-corporation is ideal for those who:
- Will wait at least five years to go public
- Deal in more than one type of stock
- Receive investment funds
- Seek maximum growth
C-Corps are not ideal for those who:
- Want to keep things small
- Want to get going right away
- Wish to simplify administration, taxes, etc.
When getting started with any legal entity, you will want legal assistance since every type has its potential pitfalls. Hart & David can assist you when determining your corporate structure.