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Your Company Structure
1. Why You Need a Company
The main reason to create a company is for income tax purposes. You will have to pay income tax on the money you earn, and you do this through some form of company structure. However, creating a company also allows you to claim expenses against your income, and thus reduce your income tax. (Chapter 5, section 2., discusses overhead cost factors and lists some of the items you may want to consider as expenses in your business.)
Another reason for a company structure is to make yourself look more professional. You can also make it look like you are a much larger company than just yourself. This can be important to some clients until they get to know you.
You therefore have to decide on the best company structure for you. This will depend on the laws in your particular state or province, and you may want to speak to your accountant and/or lawyer about what is best for you. The following are some of the issues you should consider in setting up your company:
• Will you have employees?
• How big do you think your company will grow?
• Are lawsuits possible?
• How easily do you want to draw cash out of the business?
• What is the best tax structure?
• How much will it cost to set up the company?
There are a number of different company structures you can set up. Each one has its own advantages and disadvantages. You will have to choose the one which suits your requirements and circumstances. The following sections briefly describe the different types of company structures, along with their advantages and disadvantages. These are general descriptions, and there may be variations or differences in your state or province. Much of the information in this chapter comes from the following sites that you can visit for more details.
• USA Government Small Business Administration (SBA)
• United States Department of the Treasury / Internal Revenue Service
• Government of Canada, Forms of Business Organization
2. Incorporated Company
The incorporated company is a legal entity that is separate from its shareholding owners. A corporation can be taxed, it can be sued, and it can enter into contractual agreements. The shareholders are not personally liable for the actions of the company, including the debts.
The shareholders elect a board of directors to oversee the major policies and decisions. The corporation has a life of its own and does not dissolve when ownership changes.
The cost of incorporation varies, but it generally costs around $1,000 to register it. You will also have legal fees that will add another $1,000 or more to the cost.
In the USA, corporations are registered and controlled by the state. In Canada, they can be either provincially or federally registered. In general there are two kinds of corporations:
• A private corporation can be formed by one or more people. It cannot sell shares or securities to the general public.
• A public corporation issues securities (shares) for public distribution. It has considerably more reporting requirements.
The advantages of a corporation include:
• Shareholders have limited liability for the corporation’s debts or lawsuits against the corporation.
• Generally, shareholders can only be held accountable for their investment in stock of the company. (Note however, that officers can be held personally liable for their actions.)
• Corporations can raise additional funds through the sale of stock.
The disadvantages of a corporation include:
• The process of incorporation requires more time and money than other forms of company structure.
• Corporations are monitored by federal, state, or province, and some local agencies. As a result, they have more paperwork to comply with regulations.
• Incorporating may result in higher overall taxes. Dividends paid to shareholders are not deductible from business income, thus you can be taxed twice.
3. Partnership
A partnership is a business owned by two or more people. Legally, the owners are just as liable as the business itself. The partners, or owners, must also agree on a number of issues associated with the partnership. A partnership agreement should be drawn up with the aid of an attorney that details how these issues will be shared or resolved, such as the following:
• How much money each partner will contribute to the partnership.
• How much time each partner will contribute to the partnership.
• How the profits will be shared.
• How decisions will be made.
• How disputes will be resolved.
• How future partners will be admitted to the partnership.
• What the procedure is to buy out partners.
• What steps will be taken to dissolve the partnership when the time comes to do so.
Advantages of a partnership include:
• Partnerships are relatively easy to set up.
• With more than one owner, the ability to raise funds may be increased.
• The profits from the business flow directly through to the partners’ personal tax returns.
• Prospective employees may be attracted to the business if given the incentive to become a partner.
• The business usually will benefit from partners who have complementary skills.
Disadvantages of a partnership include:
• Partners are jointly and individually liable for the actions of the other partners.
• Profits must be shared with others.
• Disagreements can occur.
4. Limited Liability Corporation (LLC)
The LLC is a relatively new type of hybrid business structure in the USA, which is now permissible in most states. It provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. The owners are members, and the duration of the LLC is limited but can be changed. Formation of the LLC is more complex and formal than that of a general partnership.
For more information about LLCs, see How to Form and Operate a Limited Liability Company, another book from Self-Counsel Press (for US readers).
5. Sole Proprietorship
Sole proprietorships are the simplest way to set up a business. In this case, the business is owned by one person, the sole proprietor, who owns all the assets of the business and any profits generated. This sole proprietor is also fully responsible for all debts and obligations related to the business. A creditor with a claim against a sole proprietor has a right against all of the owner’s assets, whether business or personal. This is known as unlimited liability. Registration requirements vary from state to state and province to province,