To many business owners, the question of “legal structure” begins and ends with the completion of a pre-printed form from Office Depot and the payment of a nominal filing fee to the State Department of Assessments and Taxation. The fact of the matter is that many business owners leave money on the table by failing to select the right business entity when they start out or by forgetting to reexamine their choice at different stages in the company’s development.
There are three primary reasons to select a business entity:
- Tax considerations;
- Day-to-day operations; and
- Exit strategy.
Sole proprietorships, limited liability entities, S corporations and partnerships are the so-called pass-through entities in which profit and loss are taxed at a personal level for the owners. Other entities, of which there are many, are subject to different tax treatment. The failure to match the type of business to the legal structure can result in significant (and often unnecessary) tax liability.
Depending upon the type of business, limited liability entities and corporations are often vastly preferable to other structures inasmuch as they insulate their owners from personal liability for acts of the entity. An owner’s personal assets (such as a house, cars, bank accounts, and personal property) are often directly at risk when business is being conducted through a sole proprietorship or in a partnership setting. Protection from risk constitutes a fundamental basis for selecting a business structure.
All good things must come to an end. Whether the business owner is anticipating a 40 year career or a two year cash-out in the business, exit strategy must always be considered in business formation. If one is looking to approach the investment community for a capital infusion, anticipate banks financing or hopes to sell to employees at a later date, it is best to select a business structure most amenable to the particular option envisioned.
Finally, regardless of their current business entity, business owners can decide to change their structure at any point in the company’s evolution. Although there may be tax ramifications and other challenges involved in such a restructuring, the benefits of the end product often outweigh the convenience of standing pat.
Bottom line: The business owner must know and understand the pros and cons of the legal structure in which he or she is conducting business.
Want to learn more about forming a business? Check these out:
- Starting a Business? Do this First.
- You’re Observing Corporate Formalities, Aren’t You?
- Download a Free Copy of The Business Owner’s Pocket Guide