When you start a new business, you will realize that there are a ton of tasks to carry out. These tasks are necessary if you want your business to flourish and bloom with profits in the future. The tasks you have to carry out in order for this to happen though are going to seem endless. You will need to start by raising money – which can take a very long time and require a ton of effort to do.
Then you will need to hire your first staff – many of whom may be incompetent and unfit for the job, and you will also need to develop a marketing strategy that involves you getting a ton of success. This list already seems endless. But before you can even start your list and begin checking off tasks from it, you will need to choose a type of business entity format for your business.
This will help you work and start your business legally. Making this decision will have a bigger impact om your future in the legal department of your business than almost any other decision you will make. This decision will decide a ton of other things for your business. Even the tax you will have to pay will depend on your types of business. Even the possibility of your getting a business loan in the future or get more investors will depend on this choice. Your business type also will determine what happens if someone will choose to sue you legally.
Most American State Governments recognize a lot of business entity types. These choices could go over a dozen or two. However, most consumers choose to opt for one of the six most popular business entity types. These range from sole proprietorships, limited partnership (LP), C-corporation, general partnership, and S-corporation. These may already seem like a ton of options to research and choose for a lot of readers. Keep in minds that not one of these is better than the others in any general way. It just varies from business to business. This article will cover the advantages and disadvantages of both and will help you to determine what is best for your business.
Sole Proprietorship is the simplest form of business entity that one could opt for. This gives you the sole power and ownership of your entire business which lets you work and make all business decisions on your own. When you launch a new business and don’t have any other owners joining in with you, then the business automatically becomes a sole proprietorship.
Despite this, you could still need an official license stating the same from your current state government. All the people who work as freelancers, service professionals or consultants are considered to be sole proprietors. This is generally a very limited option but is also more available for business that have already been established. This includes retail stores where only one person is in charge of the entire business.
Advantages of a Sole Proprietorship
Sole Proprietorships are the easiest type of business to start. They often do not require you to register with the state. This also means that you will not need to take care of any corporate formalities or paperwork. You will also not have a minimum number of meeting minutes required by the government and will also be able to deduct business losses on your tax returns.
This will allow you to maintain a profitable business with ease and without much worry at all. Moreover, filling out your taxes will also be incredibily easy. All you will need to do is take a Schedule C- Profit or Loss Business Form and then fill it out to attach to your personal income tax returns.
Disadvantages of a Sole Proprietorship
Since you are now the sole owner of your business, you will be the only one responsible for your business’ taxes, liabilities and all the debts your business may incur. Moreover, if someone does sue your business and wins the lawsuit, then your personal assets can also be at risk. They will be able to claim them.
This includes your personal bank accounts, your cars, and even your home. Moreover, lenders and investors prefer corporations or LLCs while giving loans or investing in. This is because their owners have an established difference between their personal and work accounts. This is not the case in a sole proprietorship where your personal and business finances overlap a lot. It will also be incredibly hard for you to build any business credit over time since your business will not be officially registered in any Government body at all.
Sole proprietorships are the single most common type of entity witnessed within the United States. This is because they are by far, the easiest kind to set up. The overlap between the personal and business accounting of the owner is the reason behind this. This also makes paying your taxes a lot easier. However, this overlap also results in a ton of problems. If anyone is able to sue you and win the case, them they will have the right to take your personal assets. This risk causes many sole proprietors to think over their strategy and get converted into an LLC or corporation.
Partnerships are businesses that are a lot like sole proprietorships. They are only different in one main factor and that is the involvement of more than one owner. This means that there can be more than one person liable for the business. Partnerships are usually of two types – general partnership, and limited partnership (LP).
These both have one thing in common and that is that all partners are supposed to be actively and equally responsible for the business and they also have a certain division of shares in the profits and loses of the business. When more than one person creates a business, it automatically is a general partnership. And just like in the case of a sole proprietorship, there is no need to register a general partnership with the state.
Advantages of a General Partnership
General Partnerships are very easy to start up and require absolutely no need to register the partnership with the state. This means that the partnership can function without any problems and be unregistered at the same time.
They also have absolutely no requirements for any corporate formalities or paperwork of any sort and let your business function without it. Moreover, you will not be solely responsible for business losses as all the partners will be splitting them up. Moreover, you will also be able to deduct many of your business losses on your personal tax returns.
Disadvantages of a General Partnership
Even though General Partnerships come with a ton of benefits, it does come with certain disadvantages as well. These can include and range from the fact that all the owners are going to be personally liable for all the debts and losses incurred in the business. Besides this, depending on your state, a partner can be liable for the actions of most other partners. Moreover, a single dispute between the partners can change the business and make it near impossible to get your work done.
It also becomes a lot more difficult to get a business loan or build your business credit without a registered name to back you up. This can cause a ton of problems for those who don’t already have a good credit score and can also make it difficult for you to get a big client if you are in the service sector.
Many memberships lower business risks for individuals. This is because, in a partnership, you don’t have to go all out on your own, instead multiple people share the struggles and successes with you. This can be extremely helpful in the early days of your business when you don’t have enough capital on your own to balance out your business losses.
However, despite that, you will need to choose the right partners. A single dispute can spiral and lead your business to ruins. It can also seriously hamper the growth of your business and according to many states, you will be responsible for the actions of your partner. This means that if your partner violates some terms in a contract, then the opposition can sue you as well for the same thing.
Limited Partnership (LP)
A limited partnership is different from a general partnership in various ways. One of the main ones being that it is a registered business entity. This means that a limited partnership can only be formed after having it registered with the state. In a limited partnership, there can be two different kinds of partners – those who own and operate the business along with assuming liability for it, and investors.
The first kind of partners act as general partners and are hence called as such. On the other hand, the second kind are called limited partners. Limited partners do not often get to control any business operations, and are also hence not given much liability for the business. They act as investors and don’t need to pay the same taxes as general partners do. This is because of their tangential role in the company being different from that of general partners.
Advantages of a Limited Partnership
A limited partnership is a great option for when you need to raise money. This is because your investors have the option to join in the company as limited partners and do so without any personal liability. General partners also have the benefit of getting the money they need for operation along with maintaining their authority over the business without any liability of their own. This also allows limited partners to exit their business anytime without causing any problems to the business or the partnership.
Disadvantages of a Limited Partnership
Limited Partnerships still go through some of the major flaws of general partnerships. This is seen as all the general partners are still personally responsible for the debts and liabilities of the business. This also makes limited partnerships more expensive that general partnerships and they also require state approval. Moreover, a limited partner may have to face personal liability of the business in case they start actively taking part in the business.
Multi-Owner businesses that need to raise money for starting out or for growth often opt to become limited partnerships. This is because this allows investors to avoid liabilities. There is another type of business that you may come across. It is called as an LLP or a Limited Liability Partnership.
LLPs ensure that none of the business partners have any personal liability for the entire business. Many states allow a limited kind of firms to become LLPs and this includes Law firms, Doctors’ clinics, accounting firms and some other kinds of service firms. This can seriously limit your chances of becoming an LLP. These Limited Liability firms often organize as such in order to free all the partners from the liability of the actions of the other partner. This can be seen best in clinics. For example, if a doctor commits malpractice, the fact that the other doctors share an LLP with him saves them from any legal liability.
As you can see, there are a ton of different types of business entities for you to choose from. Choosing the right one can make all the difference you need for having a successful business. This means that the kind of business entity you choose for your business should be able to benefit you and help you to generate profits beyond what you even thought were possible to create.
The kind of business entity you choose should also have a safeguard in place to put you in limited liability. You should also hire the best lawyer you can afford in order for this to be safe. After doing this, you are ready to start your business professionally. You can now move to the step about raising money to start your business.