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Setting up Your Business Structure
Now that you have an idea of your ideal business mind-set, there are some behind-the-scenes things you will need to address before you can start designing. This chapter discusses what you’ll require when starting your business.
1. Types of Business Structures
One of your first tasks will be to decide what structure you will choose to operate your business. Chapters 2 and 3 discussed some of the pros and cons of working solo and in a partnership. This chapter will cover more details of the legalities of these business structures as well as discussing your other options — limited liability company (LLC) and corporation.
In the US and Canada the business structures are slightly different. For example, in the US you have the choice of sole proprietorship, partnership, limited liability company (LLC), corporation (C corporation), or an S corporation (Inc.). In Canada, you have the option of creating a sole proprietorship, partnership, or incorporating your business. These business structures are outlined in general terms in this chapter to provide you with a broad concept of your choices. To understand these business structures, it is a good idea to read specialized books about legal business structures to help you decide which structure is best suited to your business.
It’s important to consider which business structure works best for you because things such as legal obligations, taxes (and the way you pay them), and your ability to build financial equity are all affected by the business structure you select. It’s important to note here that there is no right or wrong answer to which structure works best or which you should choose.
It’s best to get some counsel from your accountant before you choose a business structure. Tell him or her your vision for the company and the type of lifestyle you want in your business. Your accountant can help you make the best choice for what works best for you at this moment. Don’t worry about being locked into your decision either. If at a later date you want to change your business structure, you can. The following sections give you more information on different business structures.
1.1 Sole proprietorship
A sole proprietorship is what your company is by default. If you don’t organize your business in any formal way, you will be considered a sole proprietor. This is the simplest business structure you could choose for your business because there is no business apart from you the proprietor (owner of the business). Essentially all the assets (i.e., items that have a value attached to it) and liabilities (i.e., debt and other responsibilities) of the company are also attached to your personal assets and liabilities. They are seen as one and the same thing in your business.
The nice thing about choosing this business structure is that there isn’t any complicated paperwork to complete. However, many states and municipalities do require that you register your business.
As a sole proprietor, things are pretty simple and easy when it comes to operating, bookkeeping, and taxes. The big drawback to a sole proprietorship is that all your business obligations are also your personal obligations. It means you personally take all the risks and liabilities. If your business owes money, you owe money. There is no separation. Also, as a sole proprietor you won’t have a lot of taxable benefits.
1.2 Partnership
This is one level higher than the sole proprietor structure. It’s a business arrangement where two or more individuals share all the income, expenses, and risk. It’s essentially a proprietorship with more than one proprietor. As discussed in Chapter 3, there are many pros and cons to having a partnership that you will need to consider carefully if you decide to go this route.
Taxes for a partnership are slightly different than for a sole proprietorship. Different forms for taxes need to be completed by you and your partner. For more information on partnership taxes in the US, contact the Internal Revenue Service (IRS). In Canada, contact Canada Revenue Agency (CRA).
1.3 US limited liability company (LLC)
An LLC is similar to a sole proprietorship in relation to most of the organizational and taxation simplicity. It has some personal financial liability as well.
In the US, an LLC is made up of one or more owners. LLCs are afforded limited liability from company debt and are given the opportunity to choose between being taxed like a corporation or a sole proprietorship. This type of company allows small-business owners who do not want to incorporate the opportunity to have the freedom of limited liability from company debt.
The main advantage of an LLC is that the members are protected from some liability for acts and debts of the LLC, but are still responsible for any debts beyond the fiscal capacity of the entity. In most states members are treated as entities separate from their members.
One of the main disadvantages of an LLC is that there are more forms to complete. For example, you must file Articles of Incorporation with the Department of State in the state in which you will be conducting your business. The filing fee and minimum tax fee vary according to the state you do business. Another requirement of an LLC is to create an Operating Agreement that details what each partner’s participation in the business is going to be. It is not required to file this agreement with a government agency but you are required to store the agreement in the place of business. Check with your Secretary of State office for any other requirements it may have for LLCs.
See How to Form and Operate a Limited Liability Company, a book in the Self-Counsel Press Legal Series for more information about LLCs.
1.4 US Corporation
The biggest advantage of a corporation structure is that the company is seen as separate from its owner(s) in the eyes of the law. That means if you properly charter the corporation, any legal action taken against it won’t endanger you as the shareholder (person who owns shares in the corporation) beyond what you currently have invested in it. A corporation owns all the assets of your business (from the money in the bank to the paperclips in your holder). You can set up one or more people to own the corporation. Plus, there are tax benefits available to you under this structure that are not available to you under any other structure.
If you are interested in incorporating, you’ll need to follow the laws and procedures of your particular state. You can still have your corporation to operate in other states as long as you are registered to do business in those states.
The downside is that setting up a corporation structure is going to cost you more. You’ll need to pay a lawyer to counsel you and lead you through the process. There are different incorporated structures available to you (subchapter “S” and subchapter “C”) each with their own unique differences and tax advantages. Again make sure you seek counsel from your accountant and your lawyer as to which structure best suits your needs. Don’t overlook the fact that your bookkeeping will become more complex (and therefore more expensive) so you will probably need to hire an accountant to help you on a scheduled basis.
1.5 Incorporating in Canada
The advantage of incorporating in Canada is that your company will have limited liability, which means you are protected personally from lawsuits and creditors. If the corporation goes bankrupt, your personal property and
finances should be safe unless you have provided personal guarantees for the corporation’s debts. If the corporation goes bankrupt, you will not lose more than your investment. Creditors cannot sue you or your fellow shareholders for debts incurred by the corporation.
The disadvantage to incorporation is the higher costs for the