LLC, Sole Proprietorship, or Corp for a Startup?
You are about the begin your new journey by starting a new venture. But which business type is best for a startup? One of the first things you need to address is deciding on your business organization. Will you have partners or will you be the 100% owner of the startup? If you will be the 100% owner of the company then there are four business structure types for your startup: Sole Proprietorship, Limited Liability Company (LLC), and Corporation.
How to Choose a business entity for your startup?
Some entrepreneurs think that choosing the best entity type is one of the most intimidating parts of starting a business. But when you are choosing a business entity, the key is not to focus on taxes and cost of operation. First, you should start by answering some of the questions below otherwise you would find yourself in a deep hole.
These are the questions that you need to think about,
- Are you in a high-growth industry?
- Will you need investors?
- Will you need significant capital?
- Is your business highly competitive and capital intensive?
- How many owners does your business have?
- Does your company have non-resident owners?
After you answer these questions then you can make a better decision on choosing the right business structure. The business structure chart below shows the advantages and disadvantages of choosing each business entity.
Business Structure Chart
According to StartUp.com, 23 million sole proprietorships are operating in the U.S. Sole proprietorship is the simplest form of a business. You can start a sole proprietorship any time you like. You do not need to get an Employer Identification Number (EIN). Instead, you can use your SSN and start operating. You do not need to register your business or pay any registration fees. Also, if you are the owner, you have 100% control and ownership of the business. However, your personal assets are not protected under a sole proprietorship. In other words, a sole proprietorship is not a separate entity and you, as an owner, are personally liable for all business losses, liabilities, and debt.
Sole proprietorships are pass-through entities, meaning the profits are passed through the owners. Owners report profits and losses on their personal tax returns (submit Schedule C with their personal 1040 tax return).
Benefits of Sole Proprietorship
A sole proprietorship offers several benefits as mentioned above. If you are just starting and testing the waters, you are the only owner (U.S. citizen), you are not looking to bring in a partner and you do not need significant capital or your business has a low chance to be sued and you are not in a high growth industry then sole proprietorship would be a good fit for you. Some examples of a sole proprietorship include a single-person artist, small grocery store, plumber, carpenter, electrician, web designer, farmer, boutique owner, floral shop, barbershop, or restaurant.
Limited Liability Company is another common small business structure. To form an LLC you first need to obtain an EIN then register your business with the state (file articles of incorporation). LLC registration is $125 in Pennsylvania. You can form your LLC online (faster and more reliable) or fill out the forms and mail those to the state. Here at the SBDC, our consultants can assist you with your LLC registration.
LLC is a separate legal entity. Thus, the main advantage of an LLC is your personal assets are protected. Creditors cannot claim assets that are not owned by the company. Also, you as a partner or owner cannot be sued because of the actions of your employees or your partners. However, you may still be sued due to your negligence (Tip: Get business insurance!).
LLC taxation is similar to a sole proprietorship. It is a pass-through entity. Owners/members report profits and losses reported on their individual tax returns. Ultimately, the LLC is a simple organization meaning that you do not need a board of directors or other administrative requirements. Some examples include a business consultant, architect, small manufacturing company, real estate agent, or marketing agency.
The Professional Limited Liability Company (PLLC) or restricted professional company is a special form for professional services including law, medicine, public accounting, chiropractic, dentistry. To form a PLLC, you simply need to follow the steps of LLC formation.
A corporation is the most complex business structure. Corporations have shareholders (individuals or other companies). Shareholders have limited liability for debts. Corporations are considered separate legal entities. Corporations are reputable entities for investors and creditors.
The main advantage of a C Corp is that these types of entities can have unlimited shareholders (including non-U.S. owners).
C Corps are double-taxed meaning that these entities are both taxed at the company level and individual level. In other words, C Corp files taxes on its profits, and after that shareholders pay taxes on their shares. That said C Corps are eligible for deductions and expenses (e.g. medical reimbursement, fringe benefits).
S Corp cannot have more than 100 shareholders but it offers tax advantages as these entities are pass-through entities like sole proprietorships and LLCs.
Is it for you?
If your business is in a high-growth industry or needs significant startup costs/investment then a corporation is the right choice for your business. Most investors would like to invest in corporations as these entities are considered proven entities and legally, it is easier to invest in corporations for the investors. Also, if you are considering going to the public in the long term then you should consider forming a corporation.
Next Steps in Starting Your Business
After you decide the best structure for your business, go to the IRS website, get your EIN, and then register with the Pennsylvania Department of State (unless you are starting a sole proprietorship).
We are here to help!
If you still find yourself confused or need help with the next steps, here at the SBDC, our consultants can assist you. Apply for consulting and start working with one of our business consultants. We are here to help you start, grow, and prosper!