What Type Of Company Should You Form For Your Small Business?

If you're planning to launch a business, you've probably already put a great deal of time and effort into finding the perfect name, location, and other details. But one of the most crucial factors in the success of your business is the legal structure that underpins it. Business law can be complicated; what type of corporation should you form for your business? If you choose a less advantageous corporate structure, can you change this later? Read on to learn more about the most common small business structures to help you choose the one that is right for you.

Why does a business need to be incorporated?

Even if your business is a fairly casual or "unofficial" kind -- such as engaging in home-based sales of merchandise, or performing occasional construction, decoration, or cooking services for pay -- it can be beneficial to incorporate into one of the below business structures. The primary advantages of incorporating your business are the limitation of personal liability and a streamlined structure for taxation purposes. Both can help you protect your personal assets (and other income from garnishment) in the event your business is sued for personal injury, misrepresentation, libel, or an assortment of other violations.

What type of business structure should you choose?

  • Sole proprietorship

A sole proprietorship is ideal for a business you don't intend to expand -- such as direct sales or a one-person service shop. The process for incorporating a sole proprietorship in most states is very streamlined, and at the end of the year your business tax return should be similarly easy to prepare.

A sole proprietorship is generally a bad idea if you plan to take on business partners or employ a number of people, and is not as successful as the other organization types when it comes to limiting personal liability. If you choose to incorporate as a sole proprietorship, be sure to purchase an umbrella insurance policy to protect your assets from attachment or seizure.

  • Limited liability company (LLC) and limited liability partnership (LLP)

These business structures can operate for very small to medium-sized businesses, and are ideal for those who wish to be governed by a board of directors or group (or pair) of partners, rather than by a single proprietor. These business structures are also better able to protect personal assets of the owner(s) during a lawsuit than a sole proprietorship. However, you'll often pay taxes at a higher tax rate than a sole proprietor.

The primary difference between an LLC and LLP is the tax structure. An LLC operates as a corporation, and any profit (or losses) will pass directly to the owners. An LLP operates as a partnership, and any profit (or losses) will be funneled back into the partnership (with the owners often taking a salary based on these profits).