Sunday, November 05, 2006

Choosing a Business Entity

So you want to start a business. What sort of form should your business take? As with most legal issues, it depends.

Chances are you're currently a sole proprietorship. That's a fancy way of saying that you are the business and the business is you. This is the second worst form of business. Why? Because if something goes wrong, YOU get sued personally, and they can come after YOUR house, YOUR car, YOUR bank accounts. Not a pretty picture.

I said that this was the second worst form of business. The worst form is what you probably are if you are in business with someone else: a partnership. Not only are you potentially liable for your own screw-ups, you can be on the hook for your partner's as well.

What you need is an entity that limits your liability. That's where corporations and limited liability companies come in. Limited liability companies, or LLCs, are simple and effective. If someone slips and falls at you business, they can only go after what the business owns, not your personal assets. The taxes are relatively simple. More on that later.

Corporations come in two flavors: S and C. An S-corporation is a lot like an LLC, except that there are restrictions on who can be the owner of an S-corp. So why choose an S-corp? They have tax advantages in certain situations, but that discussion goes way beyond the scope of this blog and is best conducted with your CPA.

C-corps are the full smash. Microsoft, Dupont, and all the big boys are C-corps. C-corps limit your liability, but you suffer a double tax: The corporation's profits are taxed, and the distributions to the owners are taxed too. With S-corps and LLCs, the profits flow straight to the owners and are only taxed there, not at the business level.

So why would a new, little fritter choose a C-corp? He probably wouldn't. An LLC would do just fine. BUT, there are exceptions. For example, if you need to start raising capital right up front (say you're in manufacturing, or you're a lab, or you need to do some serious intellectual property protection), angels and venture capitalists won't look at you unless you're a C-corp.

Simply put, there is no one-size-fits-all solution. You need to sit down with legal and accounting professionals and tailor a business that fits you.