Let’s say you have the perfect idea for a new business. There’s a new product or service you know the world needs, and you might be the only one providing it. But you’ve never started a business before. You’re learning everything starting from scratch. One of the first aspects you’ll learn is called “business formation,” which is an actual step during the business building process that will result in making your new business a legal entity.
Before you can make your business legit in the eyes of the law, you need to determine which type of business formation makes the most sense for you and your customers or clients.
Do you prefer a sole proprietorship? These are perhaps the easiest businesses to build, in part because you will have complete creative control over where your business goes. The biggest disadvantage (or advantage, depending on what you want) is that your personal assets and business assets are bound together. Your business is tied to your personal livelihood. That means any liabilities incurred by the business are your own responsibility, too. You’ll find it more difficult to obtain loans through banking institutions. But if your business is relatively low-risk, a sole proprietorship might be the way to go!
Will you have a partner in crime? You will choose a partnership business formation. You can opt for a limited partnership or limited liability partnership. The latter means each partner has limited liability (which protects partners from debts without retaining responsibility for the actions of the others), while the former means one partner has limited liability while the other does not. Often, attorneys choose to build partnerships over sole proprietorships.
Certainly you’ve heard of an LLC: Limited Liability Company. This formation is a near-combination of corporate and partnership. An LLC is used to shield someone’s personal assets from business liabilities. Should your business face bankruptcy, you won’t have to declare yourself — which means your car, home, and bank accounts are mostly safe. The biggest thing you need to know about an LLC is that members of the formations are bound to self-employment laws and statutes. Members will need to play self-employment taxes, which can be quite large.
A corporation is a legal entity all its own. The corporation is subject to taxes and liability, but stands to make a profit. It’s more expensive to build a corporate entity, but individuals who lead the corporation are very protected against personal liability. Most shareholders can buy or sell stock, and the corporation’s day to day business won’t change. Raising funds is easier in a corporation.
Other types of business formations include an S corp, B corp, close corporation, nonprofit corporation, and cooperative. It’s also possible to mix and match sometimes. For example, an LLC might be formed in such a manner as to be taxed as a C or S corp. There are pros and cons to each type of formation, and ultimately you should research each and choose carefully.