Are you starting a business? Do you have questions about the business structure you currently use? Is everyone telling you to form a Delaware corporation? Determining which business structure is best for you will depend on a number of factors, many of which will be directly related to the type of business you are in and your plans for the future. First, ask yourself the following questions:
1. What is my business and how much risk is involved in the products I create or the services I provide? How much protection do I want or need?
2. Will I have any partners? Will all of those partners participate in managing the business or will some be more akin to a silent partner?
3. How much money do I need? Will I need to bring on investors now or in the future?
4. Do I want the entity to have a formal governing structure?
There is no one-answer-fits-all when it comes to choosing a business structure, but some structures may be better than others depending on how you answer the above questions and some other factors. And remember, companies may be able to change their structure at a later date if they think it’s necessary or appropriate.
Running a small hobby business right out of your garage that doesn’t involve any risk? A sole proprietorship may work for you. On the other hand, not all problems are foreseeable, so most business owners should take advantage of the limited liability protection granted to owners in other structures. For this reason, sole proprietorships are rather rare, and a statement made by one of my law professors years ago comes to mind: “I think there’s a good argument that advising your client to use a sole proprietorship for his or her business is borderline malpractice.” If you currently run a business by yourself that has no formal structure, then you probably have a sole proprietorship.
A general partnership has more than one owner. The perk? It’s highly flexible and you don’t need to file any formation papers with the government. The downside? All the partners are personally liable for business debts. Nearly all companies will want to have limited liability protection for their partners, but in some instances a general partnership may suit your needs. If a general partnership is right for your business, it is highly recommended that you have a partnership agreement in place. If you currently run a business with one or more other people and the business has no formal structure, then you are probably running a general partnership.
A C corporation is quite common, and it’s great for attracting investors. However, C corporations are subject to more formality than most other business structures. Additionally, C corporations are typically subject to what is called double taxation, where income is taxed when received by the company and then again when it is distributed to shareholders. C corporations are often used by businesses that want to go big. There may be other advantages to using this structure as well, and changes to the tax code effective in 2018 reduced corporate tax rates, which, in most circumstances, makes the structure more attractive to the business owner. Sometimes investors will insist on a company being a Delaware corporation. Several states have made recent changes that probably make their jurisdictions just as attractive as Delaware, but Delaware tends to give corporations and entrepreneurs the benefit of the doubt, and it has its own court that deals specifically with company matters.
S corporations are typically smaller than C corporations and receive better tax treatment. Many family run corporations are S corporations. Not just anyone can form a S corporation though, and, among other requirements, there are special requirements when it comes to who may be a shareholder. For example, there is a limit on how many shareholders the company may have, and usually the shareholders must be individuals (with some exceptions) and U.S. residents.
Limited Liability Company:
A limited liability company is kind of like a hybrid between a C corporation and a general partnership. It grants its owners, or members, limited liability protection but it doesn’t require some of the more formal requirements of a C corporation. Limited liability companies are often used by startups because there is a lot of flexibility and customization available in designing its governance structure. For a startup or a small business, and even many larger businesses, a limited liability is the default choice. Note that changes to the tax code effective in 2018 also reduced pass-through tax rates.
Limited partnerships are ideal for situations where some partners wish to participate in the business of the company while others merely wish to invest and support the company financially. Limited Partnerships consist of at least one general partner and at least one limited partner. The limited partner has a passive role in the business, typically just providing capital, while the general partner runs the business. Limited partners are granted some liability protection while general partners are personally liable for business debts. Creating a limited partnership structure should be carefully planned. A limited partnership often suits businesses that will own other companies or several large profit-generating assets. In other words, they’re typically seen as part of a much larger business structure consisting of several entities.
Limited Liability Partnership:
A limited liability partnership is similar to a general partnership except that all partners have limited liability protection. The partners may all take part in managing the business. Typically, a limited liability partnership is only available for groups of people offering professional services, such as attorneys, accountants, or architects. Note that some states allow professionals to utilize other forms of “professional” entities as well, such as professional corporations or professional limited liability companies.
Public Benefit Corporations:
A relatively new structure in many states, a public benefit corporation is similar to a corporation except when the company makes business decisions it typically must consider some public purpose, such as a social or environmental cause. A public benefit corporation may be an excellent alternative for a non-profit, especially when that company plans to conduct business in a way that might run afoul of non-profit rules.
Non-profits are typically corporations that dedicate their resources to serving some charitable, educational, scientific, or religious purpose. Non-profits, so long as they meet particular requirements, may be exempt from some taxation. From a policy perspective, this is typically because the organization serves a public good the government might otherwise need to address.
Please note that the availability of some business structures may depend on the state in which the entity is proposed to be formed.
DISCLAIMER: This article is prepared by lawyers, so of course there is a disclaimer. The above is not legal advice and is presented for information purposes only. No attorney-client relationship is formed until you formally engage us as your attorneys in writing.