As if you don’t have enough to do in the early days of your startup – what with making sure you are delivering the right product to the customers, actually building the product or service, beginning to create the buzz needed to generate demand for what you have to sell – you also need to make sure you create a legal structure for your enterprise. What you finally decide will have a significant impact on tax implications – because you are after all going to make money – whether or not you can get external financing, who has controlling interest so is the primary decision-maker and whether or not your personal assets are protected.
An article in Entrepreneur offers a great infographic giving you a basic overview of your options along with the pros and cons of each alternative. Obviously you will want to dig deeper, but understanding the terminology and at least a little bit about each option will make that conversation with your attorney go more smoothly. The options covered include:
- Sole Proprietorship: You are the only owner of the company, make all the decisions and the business revenue, it’s simple to set up and expenses are listed on your personal tax return.
- Partnership: These can be either general or limited and are similar to a sole proprietor arrangement except that one or more partners share control. A partnership does not protect your personal assets from liabilities arising from company actions. Each general partner can make decisions on behalf of the other partners.
- Corporations: A corporation is a legal entity separate from its owners so your personal assets are protected from company liabilities. Corporations have shareholders and a Board of Directors and it files its own tax return. This can lead to double taxation since both you and your company are taxed on the profits. They are more complex and decision-making typically follows a structured path.
- Limited Liability Company (LLC): An arrangement that helps you avoid the double taxation issue as earnings and losses are passed through to the owners and included on their personal tax returns.
More and more entrepreneurs are electing to form LLCs but the decision should be made carefully in consultation with legal and financial advisors. According to a recent blog post for the Keiretsu Forum:
“Choosing a legal entity for your business is not a decision that should be taken lightly. You should consult an attorney and accountant, talk to potential investors, and think about the future of your business. Three critical questions you want to answer are: (1) who will own the business and what type of economic relationship among them is contemplated; (2) how and when do the owners intended to realize a return on their investment; and (3) is the business initially expected to generate losses and for approximately how long?”
If you are interested in learning more about the tax implications of LLCs and Corporations, check out this article in the Founders Workbench.
There is a lot to think about as you prepare to launch your business. Taking the time to carefully explore your options can save you a lot of headaches in the future.