Just because you’re starting a small business doesn’t mean that you want your business to stay small. Depending on what you want to market, you may envision your business growing into something much bigger. A “startup” can be any company in the early stages of development, but the main difference between a typical small business and a startup is that the latter is focused on growth.
Generally, a startup is a business venture launched by either 1 person or a small founding team of entrepreneurs who seek to fill a gap or create a new niche in the market with a certain product or service. A startup may be financed by its founders or may try to attract outside funding through friends, venture capitalists, or lenders, and each of those funding options will carry different risks and require different strategies.
When it comes to choosing a business structure for your startup, there is no one right answer. You should consider factors such as financial projections, goals, and risks as well as local, state, and federal laws before deciding which structure suits your needs. You should carefully consider the advantages and disadvantages each business entity can offer your new company. An experienced attorney can help you understand the pros and cons of each as they apply to you.
In a sole proprietorship, there is no real distinction between you and your business—the company is basically you, and you are responsible for all your company’s liabilities. This entity is not really a legal structure, but it gives you the chance to be your own boss, with complete control over all decisions. While costs may vary, you typically only pay licensing fees and taxes. Another advantage is this type of structure is easy to dissolve; you simply stop operating if you want to close your business.
The main disadvantage is that you are personally liable for all business debt, even if you file for bankruptcy. A sole proprietorship can also limit your company’s ability to gain outside funding. Selling equity in your company would mean that you share ownership with the buyer, so only businesses with multiple owners, such as a partnership, can raise equity capital. The legal structure of a sole proprietorship also doesn’t allow it to sell shares of stock to investors to raise capital. Without these mechanisms, the owner generally must obtain business funds through personal accounts and credit, and any loans the business receives are based on the owner’s personal finances.
Because of the limited funding potential and legal risks, a sole proprietorship will not grow as quickly as other organizational structures. However, that doesn’t mean you can’t start there.
There are several different types of partnerships that you can form, but traditionally, a partnership is a business structure owned by 2 or more people that is based on a partnership agreement.
Partnerships can be attractive because they are usually easy to form. In addition, it is usually easier for a partnership to get business loans than a sole proprietorship because there are multiple credit lines rather than one. Partners share profits and losses as set out in the agreement and report only their individual income on tax returns.
There are many disadvantages with partnerships, as with sole proprietorships, because depending on the type of partnership, partners can be held personally liable for the company’s liabilities. There is also the potential for conflict regarding each partner’s role, responsibilities, and percentage of profits. The benefits that you can gain from any kind of partnership entity will be very specific to your unique set of circumstances and needs, and they will come with their own unique set of challenges, so make sure you consult with an attorney before getting started.
Limited Liability Company
An LLC is a hybrid structure that has the flexibility to combine the limited liability of a corporation with the tax benefits and flexibility of a partnership. An LLC can be owned by 1 person, but there is generally no limit on the number of members.
This structure can protect your personal assets from your company’s debt as long as you don’t act in an illegal, unethical, or irresponsible way when running the business. Profits and losses don’t have to be split equally among members; your LLC agreement can specify the arrangement you wish to have, which can help reduce conflict if members aren’t contributing equally to the company.
As with partnerships and sole proprietorships, the structure of an LLC allows you to avoid double taxation (i.e., you don’t pay separate taxes for the business entity, just the members), which is something most business owners want to avoid in the early stages of development. They’re also usually much easier to form and cheaper to maintain than corporations. The advantages to an LLC are state-specific, so depending on the state you plan to operate in, this may not be the right vehicle for your business.
The LLC structure is common in accounting and law firms, but a lot of other types of companies have been able to start as LLCs before converting to a corporation later when it made sense to do so.
The corporation is the most common form of business entity to form if you are going to seek traditional funding or sell shares of stock. Like some of the other entity types discussed, if you form a corporation, your personal assets are protected from liability for claims against your company. The ability to sell stock shares means that you can raise capital from multiple investors and grow your business at a faster rate. Corporations also offer continuity, which means that the legal structure is not affected by death or the transfer of shares.
While corporations offer many advantages to companies further along in growth, there are drawbacks to this structure at the startup phase. Corporations are also complex legal entities that are more costly to form than other structures and offer fewer tax benefits. If you form a corporation, you pay taxes as a company and as an individual. Corporations may not provide the flexibility that some startups need because they are controlled by a board of directors and have state and federal reporting requirements. Because most startups need flexibility and lower costs, it may be better to start as another type of legal entity, such as an LLC, and wait until your company’s growth reaches a higher level before you change to a corporation.
Get the Legal Guidance You Need for a Successful Startup
No matter where you are in your startup development, an experienced attorney can help you decide which business structure is right for you and guide you through the process of setting up your company. The attorneys at HPS Law group all run startups of our own, so we know what it takes to accelerate and secure your business.