One aspect of entrepreneurship that is not often discussed is that the legal entity formed for a business at its offset does not need to be its formation forever. Entrepreneurs have the option to change structures that best fit their needs, and many begin as sole proprietors. For those that are ready to make the leap from sole proprietorship and form an LLC or corporation, here are a few tips to keep in mind.
1. Determine if you are ready to opt out of being a sole proprietor.
There are certain aspects of incorporating as a sole proprietorship that cannot be found in other legal structures. A couple of these include the ability to be the sole owner of the business and call the shots. This allows you to exercise complete control over your startup. A sole proprietorship is generally considered to be the easiest structure to form, has a simplified tax process, and is the most affordable of the four major options (LLC, corporation, and partnership as the other three). It’s also a great entity if you run a business from home, like an Etsy shop or as an online consultant, where you don’t need a physical storefront.
However, the biggest drawback to remaining a sole proprietor is that there is no separation between personal and professional assets. You are liable for everything that happens within the business including losing valuable information, the company’s debts, or being served a lawsuit. Without liability assistance, this could make it tough for you to expand your business while staying protected as a sole proprietorship.
2. Decide whether an LLC or corporation is your best fit.
Before you can incorporate as an LLC or corporation, you’ll want to fully determine what each entity can bring to the table and to your business.
As one of the most popular entities, a limited liability company (LLC) allows entrepreneurs to keep their personal and professional assets separate. This is especially helpful in the event of an unforeseen circumstance and provides a growing startup with an extra cushion of liability protection. It also provides flexibility in being able to choose either an S corporation or C corporation as your tax entity. For those that qualify as an S corporation, careful planning will allow you to avoid paying significant employment taxes.
Keep in mind, however, that it’s not enough to incorporate as an LLC and be completely done with the process. You’ll also need to apply for permits (like a Sales and Tax permit, per obligations in your city, county, or state), business licenses and insurance, a DBA (Doing Business As name), and an EIN (Employer Identification Number).
For entrepreneurs with big expansion plans, a corporation offers the best of both worlds. You’ll receive liability protection for professional and personal assets within a formal business structure. This entity allows potential investors to invest capital into your business, provides the ability to issue shares, and makes it possible to take your business public. As far as taxes go, what you pay in taxes is based on what you choose to pay yourself from the corporation. You also have the option to elect an S Corporation status after incorporating to tax the shareholders, instead of the income of the corporation.
3. Look into a partnership.
Remember when I said there were four legal entities to choose from? A partnership is tailor-made for entrepreneurs that want to go into business with a partner, whether that’s a family member or friend. This structure allows entrepreneurs to share profits and losses with a partner and make decisions together.
Just keep in mind that much like a sole proprietorship where you are liable for everything within the company, in a partnership you are liable for decisions made along with the actions of your business partner.