When setting up a new business, it is important to put some thought into the legal structure of your company. Many business owners simply start the business to see if the business idea is valid before they ever even think about the legal structure. Unfortunately, this can be problematic when lawsuits arise and taxes become due.
Business owners need to determine the legal structure that will best fit the needs of the owners, investors, and of the business itself. Both the long-term and short-term needs of the business are critical when deciding what type of business entity you will need. Here are a few factors you should consider when starting a business:
Control vs. Ownership – How much control is important to you? Would you be willing to share in the businesses profit potential with others who can help you grow the business? Remember that many successful business owners will tell you that you are much more likely to succeed with multiple partners rather than try to do it all on your own. Forming a business initially as a corporation or a multi-member LLC can allow you to add additional owners as the needs of the business expand.
Tax Considerations – There are multiple options owners can select when forming a new business. Some provide more tax deductions to the owners, but may be more complicated to run. Some provide losses in the business to flow through to the owners, but may leave owners more exposed to lawsuits of the business. In the long run, the more you can save on taxes the more likely your business is able to have the capital it needs to succeed. Understanding the pros and cons of each form of business taxation will help you better select the best method of taxation for your business.
Business Failure – Are you willing to be held personally liable for the debts and obligations of the business? Every entity has different levels of protections for the ownership of the business. Too many business owners do not take the necessary steps to build business credit within the business; instead they rely on the personal credit of the owners. Unfortunately this legal shortcut can make the owners personally liable for the debts and obligations of the business. Business owners need to carefully consider the consequences of using the quick money that may be available through personal loans instead of taking the time to properly build credit within the business.
Time – Business structures vary in the amount of time and bureaucracy required to stay compliant. Proper legal formation, compliant internal documents, and appropriate accounting records all take time and focus away from making money in the business. Are you the type of person who is willing to put in the amount of time and effort needed to run the business correctly? If not, you might want to consider hiring a professional.
Cost– The type of business entity and where you “do business” can greatly affect the costs of setting up and managing the business. Expenses such as state filing fees, licensing requirements, liability insurance, sales taxes, employee taxes and professional services can add up quickly and take up badly needed capital when starting a business. Additionally, some states and municipalities have higher business and excise taxes for corporation than LLCs (or vice versa); some states don’t charge taxes on businesses.
Investments – Do you need a lot of capital to start and grow the business? Will outside investors eventually be needed? If so, those investors may prefer that your business be structured in a certain way. For example, venture capitalists tend to be more likely to invest in corporations yet LLCs provide better protection of the owner’s interest in the business from personal creditors. Business capital is one of the most important determinations whether your business will succeed or fail.
Liability – Along with being held responsible for the debts of the business should it fail, liability should also be strongly considered. High-risk businesses should be sure to protect themselves personally from anything that happens in the business. Forming separate legal entities for equipment, computer systems, databases, and real estate make the operating company less vulnerable to catastrophic lawsuits and may provide significant tax advantages for the owners. Conveying asset to separate legal entities after they have been partially depreciated can be costly and ill-advised.
Finally, new business owners often have so many “irons in the fire” that a proper legal structure becomes a mere afterthought. Rather than turning to a seasoned asset protection advisor, they simply consult with a friend or a local accountant. As a result, many new startup businesses are stopped dead in their tracks due to unforeseen litigation costs and taxes. Too many owners become personally liable for the debts, obligations, and liabilities of their company simply because they did not have the proper legal structures in place to protect them from the simplest bumps in the road. Please, take the time to ask the right questions and carefully select the best legal structure for your business.
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