The Small Business Times

The Importance Of Choosing The Right Legal Structure For Your Small Business

Starting a small business takes time, money, and effort. More often than not, entrepreneurs desire to run their businesses for a long time, expand to other states, and raise huge profits.

If this is your goal, it’s crucial to understand the need for the proper legal structure. Essentially, it defines your operational limits, separates your personal assets, and bails you out when you encounter any legal problems in your enterprise.

Some of the most common legal structures include corporations (C Corp and S Corp), sole proprietorship, Limited Liability Company (LLC), general partnership, and non-profit. Each of them has its merits and demerits.

Only when you select the most suitable will you reap its advantages in your enterprise. With that in mind, here are six important reasons for choosing the proper legal structure for your small business: 

1. Liability Protection

The appropriate legal structure can protect your business from any liability you may incur, especially when facing debts. Each has its pros and cons, so you’d want to compare the different business structures, such as sole proprietorship vs corporation or partnership vs. LLCs, and pick the most suitable one.

Here are some critical points to note between these structures:

  • Sole Proprietorship: This is easy to form and requires minimal fees and less paperwork to set up. But you should note that you’ll have to take care of your personal debts, legal obligations, and business losses. This means you may not have any liability protection. 
  • C Corporation: This requires a lot of paperwork during formation. However, your business can get liability protection without you taking care of it through your assets. 
  • S Corporation: This is similar to C Corp, only that it doesn’t pay taxes. S corps also enjoy liability protection. 
  • LLC: This is a private company whose managers are legally responsible for its debts according to their investment percentage.
  • General Partnership: This also requires little money to set up, but all partners have personal liability for all debts, legal formations, and business losses. 

Choosing the proper legal structure can ensure your business suffers little when covering arrears, forfeits, or taking care of any legal obligations. Therefore, take your time evaluating until you settle on the one that’ll benefit you. 

2. Taxes Benefits

The legal structure you select determines how many taxes you’ll have to incur on your end. It’d be best to choose the one with the least tax burden.

For instance, a sole proprietorship may have other advantages, but if you prefer it, you don’t have access to certain tax benefits since you’ll be paying them on your own.

This is the same case with C Corp, with which you may face double taxation if taxes are levied on the company’s income and at the personal level on profits. On the other hand, an S Corp isn’t taxed at the business level according to federal and state laws. 

Choosing the proper legal structure that exempts you from paying heavy taxes should be your utmost priority. Take your time and weigh every option carefully until you find one that will work for you.

3. Possibility Of Attracting Investors

Attracting investors may sometimes depend on your business’s legal structure. Some structures have strict rules, while others have no return-on-investment guarantees, and some investors may try to avoid them.

Not being able to partner with investors may be disadvantageous, especially if you’re starting your enterprise. For example, a sole proprietorship may hinder you from luring stakeholders to finance your business because this legal structure doesn’t have the conventional buying and selling of stocks.

Contrarily, C corps and S corps are appealing to most investors. Furthermore, an LLC allows you to borrow money under the company name without impacting your credit score.

Thus, selecting the right legal structure for your business’s growth should be a priority. Having more investors can ensure your enterprise grows into a large one within a short period.

You can also safeguard your business from bankruptcy since there’ll always be enough capital.

 4. Ability To Control Your Business

Some legal structures can enable you to run your business as you’d want, while with others, every decision-making is made as a company. So, depending on how you’d like to run your company, the proper structure can give you more control over your business. 

For instance, with a sole proprietorship, you can make your own decisions as you’d like to. Unlike in general partnerships, corporations, or LLCs, each member has a say in the daily running of the business, which means you have little say in what you’d like to happen.

5. Continuity Of The Business

Business continuity is a crucial consideration for any entrepreneur. The legal structure you choose determines whether or not your venture will continue operating upon your demise or incapacitation.

With a sole proprietorship, you can decide when to end your business, even on short notice. This is because you don’t need to file paperwork to dissolve it. Also, your business ceases to exist once you pass on. 

But with others, like a corporation, your business can continue even if you lose a member to death or someone transfers their shares to another enterprise. Also, your business operates perpetually even if you can no longer work.

6. Ease Of Raising Capital

Corporations can quickly raise money from investors to fund their operations. This is because the likelihood of profiting is high. But this may not be achievable with sole proprietorship since you have to raise the capital on your own, which may not be very easy sometimes.

Getting loans from the banks may not be easy since they also need to guarantee your business will grow to its potential and enable them to get their money back.

Conclusion 

Choosing the right legal structure for your small business can help you avoid any liabilities you may incur on your end. Indeed, enterprises usually face a lot of unplanned eventualities.

With the proper legal structure, you can salvage such situations. Aside from liabilities, the legal structures influence taxes, control of business operations, and investor appeal. Weigh these dynamics keenly and decide on the structure that suits you best.