Legal Components
Choosing the Best Structure for Your Business
We are not pretending to give legal advice here, so if your situation is advanced enough to require specific technical questions, you should consult an accountant and an attorney.
There are five basic types of legal entities for a business, BUT the choices for a Miniprenuer are most often between:
1. Sole Proprietorship
2. General Partnership
3. LLC
In the table below we have listed many key characteristics for each of the five legal structures, please keep in mind that some of the details may vary depending upon the State in which you incorporate.
| Sole Proprietorship | General partnership | LLC | S Corporation | |
| General Characteristics | The business has a single owner; this is the most common form of business organization | Involves two or more people who agree to share in the profits or losses of the business. | One or more general partners manage the business while limited partners contribute capital and share in the profits but take no part in managing the business. This structure encourages investment without risk beyond the capital contributed. | S Corporation status may be elected after a corporation is formed. Corporations that file for this status are taxed like a partnership or sole proprietorship rather than as a separate entity. Income is “passed-through” to the shareholders. |
| Formation | No state filing required | State filing may be required | State filing is required | State filing is required |
| Management Control | Owner retains complete control over management and operations | Each partner may enter contracts and make business decisions, unless stipulated otherwise in the partnership agreement | Owner or partners manage the business and make all decisions. Members have an operating agreement that outlines management | Shareholders appoint a board of directors, and officers are elected by the board of directors to manage the business |
| Cost of Creation | None | State filing fee may be required | State filing fee required | State filing fee required |
| Raising Capital | Often difficult unless individual contributes funds | Often difficult unless individual contributes funds | Possible to sell interests, though subject to operating agreement restrictions | Shares of stock are sold to raise capital |
| Financial Liability | Owner is solely liable for all financial obligations of the business, putting personal assets at risk | Each partner is liable for all business debts | In most cases, the LLC (not the partners) is liable for business obligations. Members are not typically liable for the debts of the LLC | Shareholders report their shares of the corporation’s profit or loss in their individual tax returns. No tax at the entity level. Income/loss is passed through to the shareholders |
| Taxes | All income and expenses are reported on the owner’s personal income tax return | All partners report partnership income on their individual tax returns. The business does not pay any taxes as its own entity | If properly structured there is no tax at the entity level. Income/loss is passed through to members.The partners report income and pay tax through their individual tax returns | Shareholders report their shares of the corporation’s profit or loss in their individual tax returns. No tax at the entity level. Income/loss is passed through to the shareholders |
| Double Taxation | No | No | No | No |
| Pass Through Income/Loss | Yes | Yes | Yes | Yes |
| Duration | Dissolved if entity ceases doing business or upon death of the sole proprietor | A partnership dissolves when a partner withdraws or dies, unless the agreement stipulates otherwise | Regulations on the continuation of LLCs vary by state | As a legal entity, a corporation may survive the deaths of its owners, partners and shareholders |
| Operational Requirements | Relatively few legal requirements | Some formal requirements but less formal than corporations | Some formal requirements but less formal than corporations | Board of directors, annual meetings and annual reporting required |
| Transferability of Interest | No | Possibly, depending on restrictions outlined in the operating agreement | Possibly, depending on restrictions outlined in the operating agreement | Yes, but must observe IRS regulations on who can own stock |
As you can see, there are many differences among the various types of structure, but most small business owners choose an operating structure based on one legal issue: their personal liability for business debts. Business owners who are just starting out on a shoestring often care most about spending as little money as possible on the legal structure of their business.
The owners of many new small businesses simply elect to remain as a Sole Proprietorship, and while this is the least expensive it is also the most risky. All liabilities as far as debts and lawsuits are the personal responsibility of the business owner and all your property is at risk. Although a General Partnership provides flexibility for adding partners and does offer some advantages over a Sole Proprietorship, each partner is responsible for all the business liabilities. Unless you absolutely trust all of the decisions of each partner, this is not a good structure for Minipreneurs.
If you decide that limiting your personal liability is worth the extra cost, you will need to decide whether to form an LLC or a corporation. Incorporation for a small business normally only makes sense if a the owner needs to take advantage of the corporate stock structure to attract key employees and investment capital.
For businesses that never go public and if limited liability is your main concern, then choosing to operate as an LLC rather than as a corporation typically makes the most sense, If the corporate stock structure isn’t something you want or need for your business, the simplicity and flexibility of LLCs offer a clear advantage over corporations.
Although there are many companies on line that will handle your business structure or incorporation needs, we recommend using Legal Zoom. They are quick, thorough, efficient and competitively priced.
