The legal structure of your company is a key decision. Here are the most common options.
Sole Proprietorship: This is the simplest structure, and usually involves just one individual who owns and operates the enterprise. Tax-wise, this structure is appealing because business expenses and income are included on your personal income tax return, and business losses you suffer may offset other income.
Disadvantages: You're personally responsible for your company's liabilities, so your assets could be seized to satisfy a business debt or legal claim. Banks and other financing sources may be reluctant to make business loans to sole proprietorships.
Partnership: In a general partnership, the partners manage the company and are responsible for its debts. A limited partnership has both general and limited partners. The general partners own and operate the business and assume liability. The limited partners serve as investors only; they have no control over the company and aren't subject to the same liabilities as general partners. This is usually not the best choice for a new business.
A partnership does not pay tax on its income but "passes through" profits or losses to the individual partners.
Disadvantages: General partners are personally liable for the partnership's obligations and debt. Each general partner can act on behalf of the partnership, making decisions that are binding on all the partners (if the partnership agreement permits). Partnerships also cost more to set up than sole proprietorships.
Corporation: Incorporation protects your personal assets from liability and makes it easier to raise money.
Disadvantages: Because a corporation follows more complex rules and regulations than a partnership or a sole proprietorship, it requires more accounting, tax and legal services. Owners of the corporation also pay a double tax: Corporations are subject to corporate income tax at both federal and state levels, and earnings distributed to shareholders as dividends are taxed at individual tax rates on their personal tax returns. (To soften the blow, pay the money out as salary instead of dividends.)
To incorporate, contact the secretary of state or the state office responsible for registering corporations in your state. Using a lawyer costs from $500 to $1,000, or you can file for incorporation on your own using books and software.
S Corporation: The S corporation has the liability protection of a regular (or C) corporation. Income and losses are passed through to shareholders and included on their individual tax returns, so there's just one level of federal tax.
Disadvantages: S corporations are subject to many of the same requirements as corporations, meaning greater legal and tax costs. Restrictions on S corporation stock can hinder efforts to raise capital.
Limited Liability Company (LLC): LLCs provide the liability protection of corporations, without the double taxation-earnings and losses pass through to the owners and are included on their personal tax returns. Unlike an S corporation, the LLC has no limitation on the number of shareholders. Any member of the LLC can have a full participatory role in the business's operation. To set up an LLC, file articles of organization with the secretary of state in the state where you intend to do business.
Buying Business Insurance
Failing to buy insurance for your startup can be a costly mistake. Most property and casualty companies offer special small-business insurance policies. A standard package combines liability; fire, wind and vehicle damage; burglary, and other common coverages. Typical qualifiers are that your business occupy less than 15,000 square feet, and the combined value of your building, operation and inventory be less than $3 million.
Basic package policies usually cover buildings, machinery, equipment and furnishings. That protects your company's computers, phones, desks, inventory and the like against loss due to robbery and employee theft, in addition to risks such as fire. A good policy pays full replacement costs. A package policy also includes business interruption coverage, which can provide enough to meet your overhead and other expenses if a disaster puts your business out of commission. Many policies also cover personal liability.
If you have employees, you'll also need workers' compensation insurance. Because insurance agents aren't always up-to-date on workers' comp laws, check with your state's department of insurance or insurance commissioner's office to see what you need.
Look for an insurance agent familiar with small business; ask your peers for recommendations. Some trade associations provide referrals and may even offer group coverage with attractive rates. Make sure the company your agent selects or represents is highly rated. Worldwide insurance-rating and information agency A.M. Best provides ratings of the financial strength of insurance companies.