As a business owner, you'll often make hundreds of decisions everyday, but one of the most
important decisions you'll make is choosing a business entity.
This one decision will impact how much you pay in taxes, your personal liability if your
business fails or get sued, and even the amount of time and money you spend on business paperwork.
I'm Priyanka Prakash, small business expert and senior staff writer at Fundera.
Choosing a business entity is complicated and ideally something you should walk through
with a business attorney, but by paying attention to a few key factors, you can make the decision
a lot easier.
In this video we're going to explain five factors that will guide you to choosing the
right business entity for your company.
Factor number one is the ease of setup.
Many business owners just want to start a business quickly, easily, and inexpensively.
Each type of business entity falls on a spectrum here.
On one end, sole proprietorship and partnerships are very easy to form.
There's really nothing you have to file with the state, and you typically need just a local
business license to get started.
On the other end of the spectrum are LLCs, S-corporations, and C-corporations.
To form an LLC, you have to file Articles of Organization with the state, and to form
a corporation, you have to file articles of incorporation with the state.
State filing fees for LLCs and corporations typically range from $50 to $200.
If simplicity is your main goal, then opt for a sole proprietorship or partnership.
Factor number two is liability protection.
Ease of setup is important, but what if something goes wrong with your business later?
Many businesses end up failing or being sued.
In these cases, choosing a business entity that offers asset and liability protection
for owners is ultra-important.
For example, let's say you run a landscaping business, and you accidentally damage someone's
house while working.
If you have a basic sole proprietorship or partnership, then your personal assets are
not safe.
The homeowner can sue your business and you personally.
In contrast, if you have an LLC or a corporation, then the homeowner can only sue your business.
Liability protection is a bit less important for online businesses that sell standard products
like apparel and don't interact much in person with customers or vendors.
In these cases, you might be fine setting up a sole proprietorship or partnership.
However, for restaurants, retail shops, and other brick and mortar businesses, liability
protection is very important.
These types of businesses will be safer from lawsuits and creditors if they choose an LLC
or corporation structure.
Factor number three is taxes.
Every business owner wants to know exactly how their choice of business entity will affect
their tax bill.
Sole proprietorships are the simplest business entity for tax purposes.
A sole prop is a pass-through entity, which means business income gets recorded on the
business owner’s personal tax return and is taxed at the owner’s personal income
tax rate.
Partnerships are just slightly more complicated because each partner pays personal income
taxes on their share of the business’s profits.
S-corporations are also pass-through entities but have one distinct tax advantage.
It stems from the fact that owners who actively participate in an S-corp are considered employees
of the business.
As employees, these owners can take some income as salary and some as dividends.
Only salary is subject to self-employment taxes, which all business owners have to pay
to the IRS to cover their social security and medicare obligations.
By smartly dividing up their income.
S-corp owners can save money on taxes.
C-corps are the only business entity type that is not a pass-through entity.
Corporations have to pay a corporate tax, which is currently set at a flat 21%, and
then shareholders also have to pay personal income taxes on dividends.
This is called double taxation, and it's a disadvantage for C-corporations.
However, on the flip side, C-corporations have other tax benefits.
For example, C-corps are the only type of business entity that can deduct the cost of
fringe benefits given to their employees.
In addition, retained earnings that are reinvested in a corporation are not subject to income
taxes.
Factor four is raising money.
When choosing a business entity, you need to consider how you plan to capitalize your
business in the future.
If you're planning to raise money from venture capitalists or angel investors, you’ll get
the most flexibility and opportunity from a C-corp.
Most investors just expect their portfolio companies to be C-corporations because they
can receive stock in exchange for their investments.
S-corporations can also issue stock, but are limited to 100 shares of stock and U.S.-based
shareholders only.
Some business owners opt to get business loans instead of raising money from investors.
In this case, it's usually easiest to qualify for a loan if you have a corporation or an
LLC.
Some banks and other lenders don't lend to partnerships or sole proprietorships because
these businesses don't offer asset protection and are more likely to fail.
Factor five is ease of maintenance.
We started with ease of setup, and we'll round out our factors with ease of maintenance.
How easy is it to keep your business going?
Once you start, you'll find the same spectrum here that you did for ease of setup.
On the one hand, there's really not much that you have to do to keep a sole proprietorship
or partnership going, other than maybe renewing business licenses annually.
There's a little more work that you have to do with an LLC.
For example, LLCs should have an operating agreement that outlines how the business has
to be run on a day to day basis.
An LLC also needs to record transfers of ownership units and hold regular member meetings.
Many states also require LLCs to file an annual report.
Corporations by far have the most ongoing maintenance requirements.
This includes creating bylaws, holding shareholder meetings, documenting company resolutions
in writing, and filing an annual report.
Shareholders also have to elect a board of directors for a corporation, which then appoints
officers of the corporation.
Those are the five key factors to consider when choosing a business entity for your company.
Keep in mind that there are always going to be trade offs.
If you opt for a sole proprietorship or partnership, for example, you will save time and expense
in starting up and maintaining your business.
However, if your business gets sued, you'll need an LLC or corporation to get the most
legal protection.
Make sure you think through each of these factors and talk with a business attorney
before choosing your business entity.
Check out fundera.com for more small business insights.
You can also go to youtube.com/funderaloans and subscribe to our YouTube channel for more
videos.
Thanks for watching everyone, and let us know if you have any questions in the comments!