When it comes to starting a business, there just seems like there is so much to do, from deciding on a name to getting the right permits and licenses, and even finding the right office space. So while you don't need one more item added to your to-do list, you also don't want to overlook what could be your most cost-effective--or costly--decision: your business's legal structure.
Should you go it alone? Get a partner? Incorporate? When it comes to making the right choice for your business, there's no one-size-fits-all answer. While the options for a new company are numerous, most teen-owned businesses fall into one of these four categories: sole proprietorship, partnership, S corporation or C corporation, each with its own set of advantages and disadvantages, from the risk of liability to income taxes. But, to start out, many entrepreneurs choose the sole proprietorship.
|Not sure which legal structure is right for you? Try them on for size with help from this how-to guide from Entrepreneur.com.|
A sole proprietorship means you are a one-person operation. The good news is that this is the easiest business entity to set up. There are no legal formation documents to file with the government, all profit or loss is reported directly on your personal income tax return, and you're the one who makes all the decisions about the business.
The bad news is, you also shoulder all the risk. And that's what keeps Kevin Hanks, 18, the owner of a bike-refurbishing business in Wilbraham, Massachusetts, awake at night. If he were to be sued by a customer, Hanks could lose all his business and personal assets.
"If a kid buys a bike, falls off and gets hurt, and says it's because the wheel I put on was loose, I could be liable," says Hanks, who sells most of his bikes through online auctions or from his Web site. "I'm considering getting insurance real soon." (Smart move--make sure you're insured, regardless of the type of business structure you choose.)
Despite the risks, Hanks thinks he made the right decision. "Right now, a sole proprietorship is the most practical choice for me," he says. "This is a lot simpler than a partnership or corporation."
Though many 'treps start off as sole proprietors, there may come a time when that legal structure no longer fits the business. That's what Jayson Meyer, the 19-year-old CEO of Meyer Technologies Inc. in Daytona Beach, Florida, realized as his business began to grow. "If I were still a sole proprietor, like I was when I started, I'd probably have more direct income," Meyer says. "But now my goals for the company are to continue building it."
Since 2000, the company has continued to grow rapidly--Meyer Technologies now has 12 employees. That's why he decided to restructure his business as a C corporation. "I looked at where I want to take the company, and that's how I made the decision," Meyer says. "If I had wanted to stay small and privately run, I would have chosen an S corporation. Since my goal is to go public, a C corporation was the best way to go."
Liability also played a part in Meyer's decision to form a C corporation for his business, which specializes in Web-based medical billing systems for physicians. "I'm a shareholder and president of the board of directors, but I have less personal liability as a C corporation," he explains.
Whether sole proprietorship, partnership, S corporation or C corporation, each business structure has advantages and disadvantages. That's why, amid the hustle and bustle of getting your business up and running, you need to give your legal structure some serious thought. Here are some of the pros and cons of a sole proprietorship, one of the most common legal structures for brand-new businesses:
- There are no legal fees to form a sole proprietorship, nor are there any annual fees.
- You can operate under your own name or a business name.
- You make all the decisions.
- All business income or loss "flows through" to your personal tax return.
- You are personally responsible for all the work, all the debts and all the risk.
- If you are sued, you could lose your personal belongings and money as well as your business assets.
- You can't offer shares of stock in your company, and it's difficult to transfer ownership to another person.
- The business assets pass on to your heirs if you die rather than staying in the business.
While you're mulling over the best legal structure for your business, you'll want to consider, among other things, the number of owners, personal liability risk, income tax and other taxes, ability to transfer ownership and assets, and the future needs of the company. And, before you make your decision, be sure to get advice on all the possible legal structures from an attorney who specializes in business law.