July Visionary Ventures: You need to start with the right business structure
By Rebecca Reimers
After months of hard work, you finally have a product or service tested diligently with market research and a launch plan. Now comes the time to officially register your business. State registration requires a designated structure, a decision that should be made based on the goals of the founder.
Will you be a solopreneur or are there multiple partners? Are loans needed from financial institutions? Do you plan to go public someday? The answers to these and other questions can help guide you in choosing the appropriate structure. In this column we’ll look at the most common types of for-profit companies and how each influences business operations, ability to raise funds, taxation and personal liability.
A sole proprietorship is simple to form for a single owner and allows for complete control of the business with few legal requirements. This structure has the benefit of “pass through” taxation, meaning business revenue is taxed once on the owner’s personal tax return. However, sole proprietorships do not result in a separate legal business entity. Thus there is no asset or liability protection to the owner, exposing the founder to lawsuits or personal bankruptcy. As a result, banks will consider a loan to be higher risk. Professional insurance may provide some level of protection for those providing a service.
Partnerships establish a business enterprise through a legally binding contract between two or more owners and are much like a sole proprietorship. Owners are not separate entities from the business, so do not gain any liability protection, but do benefit from pass-through taxation. Partnerships are common for professional groups like attorneys or doctors.
A limited liability company provides the advantages of both a corporation and a partnership structure. As referenced in the name, LLCs protect the owner(s) from personal liability, meaning personal assets are generally, but not always, shielded in the case of bankruptcy or lawsuits. In addition, LLCs benefit from pass through income, so tax rates may be lower than with a C corporation. One disadvantage of LLCs over corporations is that an LLC can’t raise funds via a sale of company shares. LLCs in Wyoming have both perpetual life and transferability of ownership — not the case in all states.
A corporation is a legal entity that’s separate from its owners and offers unlimited, for-profit growth potential through the issuance and sale of shares. Much like an individual, corporations can make a profit, be taxed, and can be held legally liable. This structure provides the strongest level of protection for owners, but comes with significantly more stringent requirements for company organization, record-keeping and reporting.
There are several types of corporations: “C”, “S” and “B.” The difference between these variations is primarily in taxation, flexibility of ownership and corporate purpose. The most common type is a C corporation. C corps are primarily suited to larger companies and companies that want to raise capital through a variety of means. Unlike the above options, C corps are subject to “double taxation.” That is, the company itself is taxed on profits and shareholders are taxed on dividends, which are distributed to shareholders from company profits. If the ultimate goal is to become a public company, a C corp may make the most sense.
S corporations are another option under the corporate structure umbrella. From a tax perspective, S corps resemble sole proprietorships and partnerships in that profits “flow through” to the individual and are taxed at the individual’s tax rate on their tax return. S corporations are also more limited in flexibility of ownership, including limiting the total number of shareholders and the type of shareholder allowed (for example, individuals are allowed but not LLCs or trusts).
A benefit corporation, or B corp, is a type of for-profit corporation designated by the IRS with the dual goal of making a profit and doing public good. Traditionally, C corporations have had one goal — increasing shareholder value. Conversely, B corps require decision makers to widen their scope and consider impacts on employees, the community, society, and the environment. Directors enjoy an elevated level of legal protection for “triple bottom line” based decisions.
While B corps are different from C corps in mission, accountability and transparency, they are taxed in the same manner. Note that benefit corporations are created from state law and Wyoming does not legally acknowledge B corps. Therefore, companies seeking this designation must incorporate in a different state. Some states require B corps to submit annual benefit reports that demonstrate their contribution to the public good.
While this isn’t an exhaustive list and is not legal advice, we hope it gives you an overview of options for establishing your business. However, you should always consult a lawyer and other experts when making important decisions about your venture.