As a small business owner, you most likely run a sole proprietorship. You’re not alone either, as the SBA reports that a little over 70% of U.S. businesses are sole proprietorships. Ultimately, however, a sole-proprietorship may not be the best type of entity for your specific business needs. You could choose to incorporate or form a limited liability company instead – both provide plenty of benefits, though they can be more complicated to create and run. Before you close your eyes and start to play a game of eeny, meeny, miny, mo with legitimizing your company, take a look at your business, figure out where you want it to go, and ask yourself these three questions.
What am I willing to risk for this business?
You’ve probably already risked quite a bit getting this company off the ground. You may have quit your job, taken out loans, and spent countless hours prepping an office space or store. However, you could be risking a lot more simply by running your business as a sole-proprietorship. Everything your business owns, and owes, is technically tied to you. And while 100% ownership may sound nice, if the business folds or you get sued, your personal assets could be seized to pay for the business’s debts. Corporations and limited liability companies are treated as their own, separate legal entity – that means that the company’s assets, and not yours, are on the line.
Will I ever want investors?
If so, then you definitely need to incorporate. Outside investors can technically buy into an LLC as well, but the process isn’t as straightforward or as understood as investing in a corporation. Plus anyone that buys a stake in the LLC, even if it’s small, will typically have full management rights, unless agreed otherwise. Investors are also much more interested in putting money behind a company that may, at some point, have an IPO since that is where they’d make most of their profit. Just remember that, if you do start selling shares of your company, you’re effectively bringing on a slew of new owners to whom you have a fiduciary duty.
How much time do I want to spend as an administrator?
Running a corporation is very different than running an LLC or sole-proprietorship – you have to have board meetings, vote on most major business decisions, and adhere strictly to corporate bylaws. It takes a lot of time and effort to run a corporation, which is why business owners sometimes shy away from them. Profits are also taxed twice – once at the corporate level, and again as whatever income you earn from the corporation – and to avoid that you have to file a special form for S Corporations and adhere to even more rules. An LLC, on the other hand, is really easy to run, and it has a pass-through tax structure by default. Plus it gives you all of the same liability benefits that a corporation does. For most small business owners, an LLC is the preferable option.
However you decide on an entity for your business, the final decision is yours. You know your company better than anyone else, and you know what you want it to become. But remember that you’re not married to the entity type you choose either. You can create and dissolve business entities as much as you like, but doing so will take a lot of time and money. I recommend you really think about which type of entity suits your needs, and then stick with that entity for as long as you can. Limiting your personal liability is one of the smartest decisions you can make as a business owner; you just have to spend a little time deciding on the best entity for you.