Article written by Priyanshi Trivedi. Edited by Sugandha Nagariya.
A lot of people dream of creating a startup.
But very few think of how they should structure their business. Well, since you are reading this article, you deserve a pat on the back, as you’ve done the first step.
Leave the rest to us. By the end of this article, you will know all the types of business structures out there, the pre-requisites to selecting a business legal structure and the pros and cons of each of the structures out there.
Being an entrepreneur and being an employee in a business is a totally different thing. As an entrepreneur there lies many responsibilities, from brainstorming the product you will sell to analysing the demand and supply in market.
Each of these plans have to be done and you also need to considering various risk factors if you want to make your business successful and also fulfilling the needs of your consumers.
Thinking of an idea and implementing it to start your business is not a piece of cake, you need to analyze the needs of market which you want to serve.
You take to decide on a revenue model, a business plan and a business model.
If you want to create a successful startup, then, you need to sync up with various plans, accessing your finance keeping your budget in mind, as well as having to run through a bunch of legal paperwork each day.
You also need to decide upon your business legal structure, that is whether your startup is going to run as a sole proprietorship, partnership or any other type of business.
Therefore in this article, I am going to show you the legal structures for businesses and how you can choose the best legal business structure for your startup.
But, before you select a legal structure for your business, you need to go through some pre-requisites-
#1. Getting an Innovative Idea
The first thing that everyone needs while commencing a new business is an innovative idea.
Your idea is the first step that you need to take to start a business. The key to this is to list down your innovative ideas, and see what makes you different from others.
Then you need to create a SWOT and PESTLE test for your business, to make sure it will be sustainable in the long run.
Remember that your business structure actually depends on the type of business idea you have. For example, LLCs are best suited for consultancy whereas Corporations suit the need for large capital intensive businesses like real estate.
However, you need to make sure your business idea resonates with the type of entrepreneur that you are.
#2. Effective Planning
No business works without a proper business plan. No matter, how game-changing your business idea is, you need to plan your business.
It’s better to analyze your plans and prove yourself right before indulging yourself totally into the startup. A brief business plan should always contain a detailed market research.
A plan should be easy to understand, so try not making it much complicated.
Principal and subsidiary plans should be made. So, if one fails, you have another option to work with, again it should be strategic and relevant to the conditions of business.
A business environment should always be considered while making plans and if necessary, then according to the business environment the plans can also be changed as per the conditions.
Having entrepreneurial knowledge is definitely a cherry on your cake. It helps you make right decisions about your business and has also the ability to save you from risks.
The main thing that comes here is law. You need to know the legal procedures and business laws that come under various states of the USA as each state of the USA has different laws.
A legal consultant or advisor might lead you to take better decisions, and also reading various articles by experienced and successful business tycoons lead you to gain knowledge on the business that you wish to undertake.
However before allowing a legal consultant to take decisions on your behalf, make sure you create a power of attorney.
Registering your Business
This is the part you have been waiting for. However this is also the “not so fun” part where you need to painstakingly go through the legal procedures, paperwork and register your business.
This might take a little time but the sooner you get this over with, the better. Here you need to decide your legal business structure, as well as your business name, and get it registered with the government, getting a US tax code, getting a license to perform legal business, getting a seller’s permit etc.
Business in USA, works on different levels that are federal, state, and sometimes even local levels.
Now, all these three levels have different laws made and you need to check the requirements that are in place in those particular areas for starting a business.
By registering your company with the government you need to make sure that you are registered in all the three levels and if the company is not registered in the required levels your business won’t be a legal entity.
- How to Form an LLC in the US (in 9 Steps!)
- LLC vs LLP – What’s Better?
- LLC vs LLP: Which has got a better taxation policy for your startup?
Choosing your Legal Business Structure
Choosing your business structure is the most important and crucial thing when it comes to a startup.
By considering all the elements of business that is management, planning, organization, taxation issues, legal procedures and issues, etc. to select your proper business structure you need to do in depth research and acknowledge the types of entity US has to establish your business.
After planning for marketing, your main objectives of business and factors affecting business should be considered and a proper suitable business structure should be selected considering your requirements. As this article is mainly focusing on the business structure, now we will have a look at the entities, their working of tax, advantages and disadvantages.
United States has many forms of business entities, but there are mainly four types.
And, here is all you need to know about them-
As the word itself suggests that Sole Proprietorship runs by a single individual, he is the only one who is managing the business assets, liabilities, and profits.
Here there is no distinction between the persons who owns the business and the business itself.
For example, running an art studio, IT consultants etc, can be considered as sole proprietorships.
In US nearly 72% of all the US businesses are running through via this structure.
Among the four main entities, it is the cheapest structure for a startup. However there is unlimited personal liabilities for losses incurred by businesses or of any legal actions.
Profit earned are taxed as personal income.
Here it is not necessary to register your unique name and you can simply do business with your name too. But if you want to give it a name then you need to go by the “Doing Business As” (DBA) name or the factious name for your company.
The Working of Tax in Sole Proprietorship
The proprietor himself is responsible for the transactions of debts and liabilities the business has. Because he is the one managing the business. Sole proprietors pay taxes on a business income on their personal tax. With this, they also pay self-employment taxes on the money they earn.
Advantages of a Sole Proprietorship as a Business Legal Structure
- Can be established easily, instantly and inexpensively
- Business and personal assets can be same, no pressure on making different accounts for them.
- Comparatively, have very little formalities to go on.
- No unemployment tax to be paid by the owner of the company. (must pay the unemployment tax for the employees)
Disadvantages of a Sole Proprietorship as a Business Legal Structure
- Capital cannot be raised by selling an interest in the business.
- Sole proprietorship barely handles the death and incapacity of the owners, hence the business dies when its owner dies.
- For the debts, loses, and liabilities the owner is having unlimited personal liability towards the business.
A partnership comprises two or more persons to run a business. The word “persons” include individuals or a group of individuals, companies or corporations.
The partners share their profits and controls business operations. Here the partners are jointly or separately liable for debts incurred. Example for partnership are lawyers working and managing a firm.
As the federal system states govern the different laws but most of the states of US has adopted Uniform partnership Act. Depending on the management, responsibility, liability and shares partnership is further divided in three forms. Here is a brief over view of it-
- General partnership-
It is a form of partnership where the partners share their liabilities and responsibilities equally. Partners have unlimited liabilities for the debts incurred in the business which also consists of the debt incurred by another general partner.
Usually general partnership is a transient business structure. Due to having no real value, most startups which start as a general partnership usually move over to a Limited Liability Partnership.
- Limited Liability Partnership-
This type of partnership involves one general partner who assumes full responsibility of liability of the company and other limited partners who take limited responsibilities and liabilities it also depends on the percentage pf investment, that the partners are making.
Limited liability Partnership
It is a type of partnership where there is no general partner and every partner holds limited liability.
Unlike general partnerships here the partners are not personally liable for the acts done by other fellow partners or the debts and contractual obligations of the business.
For the partnership to exist following factors are to be determined.
- Intentions of parties
- Joint administration
- Joint control over the business
- The investment of the partner
- Common ownership of the property
Working of Tax in Partnership
As far as partnerships are concerned, they themselves are not actually a part of federal income tax.
Partnership is not a taxable entity. It itself is not taxed on its income, but it is taxed according to the number of shares partners hold from the company.
Advantages of a Partnership as a Business Legal Structure
- Compared to the Limited Liability Companies and corporations, partnerships are less expensive like sole proprietorship.
- Here every partner has access to capital and credit, unlike sole proprietorship where the owner is the only one who brings the capital, here partners brings whatever amount they want to bring in the business by taking personal loans too.
- As per US laws all the profit made by the business goes to the partners only.
- Combined skills and knowledge of the partners make the partnership worth more and with this it also gets a punch of innovative ideas.
- As discussed above partnerships has great advantage on the tax.
Disadvantages of a Partnership as a Business Legal Structure
- In general partnership the partners are individually liable for the actions of partners. With this the federal or state government might cease the assets of the business if the assets are not sufficient to pay the debts incurred.
- As there are two or more than two people involved in a partnership, disagreements related to management, decisions, policies, etc has a high ratio.
- Determining the profit share might become an issue for the partners as they might not agree on sharing a particular percent of share to other -deserving partners.
- Bankruptcy and death of any partner will result into termination of a partnership.
Limited Liability Company
If one is looking for flexible business structure then Limited Liability Company is really a go-to. Liability here is limited.
It is legal form of company providing limited liability to owners in many jurisdictions.
Limited Liability Company is the most relevant business form in the USA.
It is a US specific form of Private limited company. It is a hybrid form of entity that consist of a combination of characteristics of corporation with those of partnership, and sole proprietorship.
Some famous examples of LLCs are Blackberry, Sony, Nike, Pepsi-Cola etc.
It is not a form of corporation though. Corporate tax rules are adapted instead of being treated as a partnership. It is form of a business structure that that is allowed under state statutes and varies from state to state.
Articles of association is required in LLC and should be filed with government.
To start LLC, members need to give it a good name and then the article of organization is made which consists of powers, duties, responsibilities, liabilities, etc of the members also address of members, and the agent via whom the company is registered is to be mentioned and should be filed with the government.
To get Employment Identification Number (EIN) the paperwork and the fees for registering the company should be submitted to the federal level.
Here owners are not personally liable for its debts and liabilities of the company. Another interesting thing about LLC is that any individual, corporations can also change themselves into LLCs but only banks and insurance companies are not allowed.
- Working of tax in A controlled Liability Company
There is a bit of relief in tax system for LLC as they are not taxable instead here the profits, and losses are ‘passed through’ to members who claim them on their tax returns. Which means that not the LLC, but the partners are taxed.
Hence, the factor of tax saving plays an important role here.
Advantages for a Limited Liability Company as a Business Legal Structure
- There is a limited principle’s liability here.
- Better protection for personal assets as the members are usually not liable for the company’s debts.
Disadvantages for a Limited Liability Company as a Business Legal Structure
- As it is a complex business structure, the legal procedures and paperwork might get increased with the fees.
- The company might gets dissolved by the death or bankruptcy of any member.
- If your goal is to become a public traded company then choosing LLC as your business structure is not a good decision.
Related post : The Definitive Guide to Choosing a Revenue Model for Your Business
A corporation is an organization usually a group of people or company authorized by the state to act as a single entity and recognized as such by the law for certain purpose.
Many states follow Model Business Corporation Act. States also possess registration laws requiring permission to incorporate them whereas in various other states there is no restriction imposed on them.
The component of federal Corporation law since Securities Act 1933, regulate how securities are issued and sold. Corporation is treated as a legal person by law. The shareholders are personally liable for corporate debts. In this business structure, the death of officials or stockholders does not alter the structure of the corporation.
Corporate laws deal with the formation of corporations and is related with the contracts and commercial laws.
A corporation is different in 50 states and may become authorised to do business in each jurisdiction except that when a corporation sues or is sued over a contract, the court, regardless of where the corporation’s headquarters office is located, or where the transaction occurred, will use the law of the jurisdiction where the corporation was chartered.
When a group of people together make a plan of incorporating something, they possess the right to make a contract, to sue, to be sued, possession of the property of the corporation etc.
Each state in the United States has their corporate laws. There are certain federal laws incorporated, and the licensing systems is also incorporated with it like for public transportation and communications.
Corporate law professionals also construct joint ventures, licensing arrangements, merger and many other transactions that corporations are into.
Examples of corporations are Adidas, Adspace networks, American Express, America Air linens, etc.
As far as United States is concerned there is no limit for capital in corporation.
Some days back, I wrote two articles on legalities surrounding real estate development in California and New York. It goes without saying, if your business requires large capital contribution, you are better off creating a corporation for your business needs.
Read more about the legalities of operating a company in the US.
Working of Taxes in Corporations
The United States tax code is very complex to understand hence a careful planning and consultancy is required. Companies are subject to separate federal state and local tax as before dividing into levels.
Federal government uses IRS (Internal Revenue Services) to collect income tax, capital gains tax, dividend tax, other incomes, employees payroll taxes, etc.
There are two options for corporations to pay taxes as far as United States is concerned; that is either C corporation or S corporation.
C corporation are separate taxable entities, they file tax return, and pay taxes at corporation level, while S corporation is considered as “pass through entity” which means that business itself is not taxed instead of which the income is reported on the owner’s personal tax return.
To fill the taxes by S corporation following things are required; to be a domestic corporation, have allowable share-holders, maximum 100 members are allowed, stock of only one class, should not be an ineligible corporation.
Advantages for Corporations as a Legal Structure for a Business
Personal assets are saved as the share holders are having limited liability. They are liable up to their investments only.
By selling share or issuing bonds the, a substantial amount can be raised by publicly held corporation.
Transfer of ownership – If the corporation is structured in an S-corporation form then profits and losses are passed through to share-holders.
Ownership can be passed through generations.
Disadvantages for Corporations as a Legal Structure for a Business
There can be the problem of double taxation.
Substantial amount of paperwork is required and various types of incomes taxes are to be paid depending on the firm. This works differently when an S Corporation is concerned.
Trademark Your Business Name
After selecting the legal structure of your business, an interesting yet a bit complicated step comes, that is to register your company name. You will have to register your company name if you are going to name it something other than your own personal name.
You need to know whether the name you have given to you company is available in your state. A name similar to any other company won’t be allowed.
Then comes the research on the trade mark.
Then you need to trademark your business’ name.
Trademark gives your company the protection of words, logos, symbols, and names, and will distinguish you from other companies. It costs $275-$375 in the USA and additional attorney fees to file a trademark.
Not trademarking your business name or logo will allow counterfeits to legally rip you off.
In fact, Supreme has first-hand experienced this.
Related post: How You Can Register Copyright in USA
Now You Need A Seller’s Permit
This allows you to sell your products and services within the jurisdiction granted to you by the permit – all by getting the license and sales tax code. It should be registered with the state, where you want to do business in.
It can be registered through the board equalization, and many other Government authorities. Further, creating a brand identity and building your presence online plays an important role for marketing is the most important step to make your product reach to your customers.
These are the after steps, but firstly choosing the legal business structure by determining the business factors are important which is explained by us previously. Now that you have selected a proper business structure make sure you are not making any of these devastating startup mistakes and you’re set!
For any queries or help with your startup, feel free to book a free consultation with us. You may also check out our list of services if you need any help with your business efforts.
Author Bio: Priyanshi Trivedi is a B.A.L.L.B (Hons) student at The Maharaja Sayajirao University of Baroda and an intern at WinSavvy. Connect with her on LinkedIn.