As a small business owner, you face a litany of important decisions each and every day. One of the most foundational decisions you’ll ever make is which legal structure to choose for your business. There are a few options (Sole Proprietorship, Limited Liability Company, Corporation, and beyond), but the distinctions between these options can be profound: In fact, the structure you choose can affect everything from your legal liability to how you pay your taxes.
So what should business owners make of each legal structure? And what’s the process for formally registering?
Sole Proprietorships
Let’s start with the most basic option. A Sole Proprietorship is a business in which one person (the owner) makes all decisions about the company’s strategy and its daily operations. The business owner gets to claim all revenues, but is also on the hook for all business debts and liabilities.
A Sole Proprietorship offers a number of advantages, including pass-through taxation, very minimal regulatory oversight, and plenty of autonomy and control for the business owner. There is also one huge drawback, which is the absence of any legal liability protection. Simply put, if someone brings a lawsuit against your business, it means you’re exposed to personal legal risk and financial loss.
How to Register as a Sole Proprietorship
When it comes to registering as a Sole Proprietorship, there’s really nothing you need to do. When you start generating self-employed income (and declaring it as such on your personal tax returns), the government will automatically classify you as a Sole Proprietor. In other words, this is the default position. However, you may still need to apply for business permits or licenses, depending on your area and depending on your industry.
Partnerships
Another legal structure you might choose for your business is the Partnership. In many respects, this is identical to the Sole Proprietorship model, with many overlapping pros and cons.
The big difference is that, in a Partnership, you share duties, responsibilities, profits, and liabilities with one or more business partners. This means your control over the company may be somewhat diluted; or, to look at it from another angle, it means you get to work collaboratively to grow your business.
How to Register as a Partnership
In addition to obtaining licenses and permits, you should create a partnership agreement, specifying how you will allocate duties, responsibilities, profits, and liabilities between partners.
LLCs
For many small business owners, the best way to establish your business is by registering as an LLC.
When you register your business as an LLC, you create a distinct legal entity; in other words, it creates some distance between you and your business. You can separate your business assets from your personal ones, and you can limit your personal exposure to any legal risk.
The LLC format is popular for a number of other reasons, as well, including pass-through taxation, the ability to transfer ownership, and a range of options with respect to how you manage your business.
How to Register as an LLC
The actual process for registering your business as an LLC is multi-faceted, and it can vary from state to state. You’ll always want to verify your state-specific guidelines; for example, if you live in the Golden State, you’ll want to investigate the requirements to start an LLC in California. With that said, the typical process looks something like this:
- Choose a name for your business. Naming your LLC is more complicated than you might think. That’s because it’s legally required that every LLC have a name that is unique… that is, not in use by another LLC within the same state. In most states, searchable online directories are available, allowing you to confirm that your choice is an option.
- Find a Registered Agent. It’s also mandatory that your LLC have a Registered Agent, which may be either an individual or an organization tasked with receiving your legal correspondence. Your Agent must have a physical mailing address, not a PO Box, in your state of registry.
- File Articles of Organization. You will need to complete this document and file it with your Secretary of State, sharing some basic information about what your LLC is established to you. Additionally, you will need to pay your state’s registration fee, which can be up to $300 depending on the state.
- Create an Operating Agreement. While not legally mandatory, this document can help you minimize any legal friction or misunderstandings between you and your business partners.
- Claim an Employer Identification Number (EIN). You will need to claim this free number from the IRS before you can file taxes or administer payroll.
- Start a business bank account. Verify that you have a business bank account that is not connected to any personal checking or savings accounts.
Corporations
A final option to consider is incorporation.
A Corporation is governed by a Board of Directors, with ownership determined via the sale of ownership shares. Corporations provide robust legal protections, and they can also enable you to “go public” selling a stake in your business. However, Corporations also come with the most onerous regulatory environment, including requirements to issue shares, assemble a Board, hold annual meetings, and make public disclosures.
To establish your business as a Corporation, and to ensure compliance with all of these regulations, it’s almost always advisable to seek legal counsel.
Register Your Business Using the Right Structure
As you consider which legal structure is right for your business, there are a number of factors to consider. Some of these factors can include taxes, the regulatory environment, ease of transferring ownership, legal liability, and more. Of course, as you think about which structure is best for your business, you’ll also want to take into account the steps required for registering.
