How To Structure Your Business: What Legal Entity Should You Choose?
Before you start providing any services or earning any money with your small business, you want to ensure it is set up correctly both legally and tax wise. This is where the structure of your business comes into play.
You'll need to understand what kind of business structure you need to set up - Sole Proprietorship, Partnership, Limited Liability Company (LLC) or a Corporation. Things can start to get a little confusing here, so to break it down, here are high level definitions of each:
- Sole Proprietorship
In this business structure, you run the business alone and are personally responsible for all of the related liabilities.
In this structure, you run the business with a partner or multiple partners and the business is managed based on the agreement you set up. You and your business partner(s) are personally responsible for all of the related liabilities.
- Limited Liability Company (LLC)
In this structure, you have limited liability (similar to a corporation), which means you have no personal liability for business debts and claims. You'll also have the flexibility in your management structure and ownership similar to a partnership. Owners in a LLC are called members.
- Corporation (S or C Corp)
Here, your business is a separate legal entity and only the entity itself is held legally responsible for any liabilities taken on. Owners are called shareholders. There are two different type of corporations, C corporation and S corporation and the main difference is the way each entity is taxed.
How do you decide on a business entity?
If you aren't sure what structure to choose thats perfectly fine. Your choice is not permanent. For example, if you start out as a sole proprietorship and your business grows and you want to reduce your personal liability you can always convert to an LLC or corporation. You just need to make sure you follow the government guidelines to do so.
Below are two invaluable resources that will you most likely need as you begin your small business journey. These resources go into a lot of detail regarding the business structures mentioned above including the pros and cons as well as the specific steps you need to take to set up your business under of these structures:
You should spend some time doing research on the different business structures, which one you'd like to set up and the related costs, legal and tax requirements of each. If necessary you can talk to professional like a tax accountant or a business lawyer to help guide you.
Deciding on a business name
Once you've decided on your business structure, the next thing you need to do to start operating legally is decide on a business name (if you haven't already), register the business name and register the business with any US state agencies if necessary.
FYI - Your business name is kind of a big deal! This is going to reflect your brand identity and be the first introduction the world has to your new venture. But before you decide on a business name, here are a few things to think about:
- Will your business name appeal to your demographic?
- How unique is it?
- Is the web domain available?
- Has it already been trademarked by someone else?
Once you've answered these questions you can go ahead and register your business with your respective state. Your business name which will be known as your trade name, fictitious name or DBA "Doing business as" name.
Applying for an EIN
You also need to apply for a business tax ID or Employer Identification number (EIN) on the IRS website if you are required to do so based on your business structure you've selected. Your EIN is like your social security number, but for your business. It will tie into your business taxes, hiring employees and other important and required legalities.
While each step I've listed above will requires some time to execute, it's important to you take the right steps to set up your business correctly to avoid any legal potential issues that could arise from not getting it done.
Bola Sokunbi is the founder of Clever Girl Finance and she's passionate about helping women take control of their money so they can live life on their own terms.