How Should You Choose Your Business Entity?

Choosing the right business entity image 8300One of the biggest decisions you’ll make early on as an entrepreneur is what type of business entity to choose for your company. There are many types of legal entities available, each with distinct advantages and disadvantages, and your choice could impact the efficiency and benefits your business receives for years to come—if not the entire lifespan of your company.

It’s relatively easy to start a business online, even if you choose a more complex business structure like an LLC or a corporation. But making the decision can be incredibly difficult—especially if you don’t yet have all the details on how your business is going to operate.

Business Entity Options

First, you should familiarize yourself with the types of business entities that are available. Some have restrictions that will rule them out as an option for your business immediately, and others will offer must-have perks, allowing you to solidify your decision rapidly.

These are some of the main business types to learn:

  • Sole proprietorships. First, there are sole proprietorships, which as the name suggests, are exclusive for sole business owners. These are simple businesses that can be started very easily, but don’t offer many inherent advantages, and don’t offer much potential for expansion.
  • Partnerships work similarly to sole proprietorships but are only available for businesses with two or more founding partners. They, too, are simple to start and easy to manage, but offer limited advantages in other areas.
  • Limited liability companies (LLCs). LLCs are treated as a separate entity from a legal perspective; in a sense, the business can make its own decisions, take on its own debts, and be held liable for most of its actions. You can take advantage of this if you’re a sole business owner or if you have multiple partners. This is also a pass-through entity for tax purposes, and is relatively easy to start and manage, though it’s arguably more complex than sole proprietorships or partnerships.
  • Corporations are the most formal business structure and are harder to start and manage due to the rules and restrictions placed on them. They have the ability to issue public shares as a way to raise capital, making them ideal for expansion, and offer significant liability protection for their owners. Many subtypes of corporation exist, including C-corporations and S-corporations, with the most notable differences being related to how shareholders are managed.

There are other types of businesses to choose from as well, including subtypes of these business structures, but these are some of the most popular and easily distinguishable.

Creating a Business Plan

Before you get too comfortable with a particular business structure, spend some time drafting and polishing a formal business plan. Only by researching and writing a business plan will you become familiar with the inner workings of your business, including how you’re going to generate revenue, what kind of competition you’ll face, and even how you’re going to expand (or if you’re going to expand) over the next several years. These details will be important as you narrow down the business entities available to you.

How to Finalize Your Decision

Chances are, you’ve already narrowed down your decision to a handful of “final” candidates. So what can you do from there? Ultimately, you’ll want to look at these important factors:

  • Each business will be taxed slightly differently. Sole proprietorships and partnerships have less control over how they’re taxed, but are very simple to deal with. Corporations pay a tax rate on income in addition to their owners paying taxes, resulting in double taxation in many cases, but owners have significant control over how this applies.
  • LLCs and corporations offer liability protection to their owners, which is ideal for some types of businesses. Sole proprietors and owners in a partnership may be held personally liable for actions they take in their business, which can be problematic.
  • Some businesses are easier to start than others, and are subject to fewer rules and restrictions. If you’re looking for something that’s simple, sole proprietorships and partnerships tend to be better. LLCs are a good middle ground between these and corporations.
  • If you’re looking to have multiple locations or expand to a national or international scale, you’ll need one of the bigger, more complex types of business entities. Corporations are ideal here because of their liability protection and innate ability to raise capital.

There isn’t a “right” answer for which business structure to choose, and you should be able to change business structures later if you find your business has different needs. However, it’s important to spend some time researching and making a formal decision that has the best chance of benefitting your business in the long term.