Deciding to start a business is a huge step that has many difficult decisions following that initial one. One of the biggest decisions you will be required to make is deciding on the business structure that you will use. Each type of business entity has its own advantages and disadvantages so getting an understanding of what these are will help you to make a decision. In general, choosing the right entity for your business will help you to reduce the amount of taxes you are required to pay, handle personal liabilities, obtain appropriate funding, and provide reasonable expectations about how the company will be handled. Most business entities choose to establish sole proprietorships, partnerships, corporations, or limited liability companies (LLCs).
The right business entity for you will limit the amount of personal liability you have to take on. If you are a freelancer, depending on your industry, your legal exposure may be very low so a sole proprietorship may be right for you. On the other hand, if you are at a higher risk in cases such as where you have large financial obligations, then an LLC may be best for you. A drawback of the sole proprietorship is that banks and lending institutions might be reluctant to approve loans for you. They will be more likely to lend loans to LLCs and corporations. With sole proprietorships and partnerships, it is also possible for your personal assets to be seized in the event of a lawsuit, so consider this possibility carefully. The idea is to protect your personal assets as best as you possibly can.
The next thing you should consider when deciding which business entity is right for you is your tax obligations. Truthfully, it is better for you to consult a lawyer about your different options since they will better be able to advise you about it. In general, corporations have the biggest tax obligations. Sole proprietorships, LLCs and partnerships are way more simple. With the latter three, you can actually file your income onto your personal tax return. On the other hand, corporation earnings are taxed twice, which is something most people try to avoid.
The amount of record keeping required for each business may also factor into your decision. For instance, if you have a sole proprietorship, you will not need any special state registration. Neither is it required for a partnership. However, both partnerships and limited liability companies require some amount of record-keeping. Corporations require you to do so more extensively, and each state will have its specific and differing requirements.
Choosing a business entity clearly has big implications for how your business operates going forward so it is clear that you should put a lot of thought into making the decision. There really is no ‘best’ entity type and there is no one-size-fits-all option. Instead, it is all about choosing the option that will be best for the type of business that you want to operate.