Your Business Structure is a Key Variable in the Financial Success of Your Company

Running a business is hard. Each day brings new challenges. Employees underperform. Equipment breaks down. Technology doesn’t work the way you thought it would. These are examples of operational dysfunction that can be easily corrected. Financial dysfunction is more difficult to fix, particularly if it’s connected to your business structure.

Entrepreneurs need to make several decisions before they become founders. One of them is how to structure the company. Operating as a sole proprietorship can work for at-home eCommerce businesses and one-man service operations. Business owners who want to grow and scale need to incorporate. A more detailed explanation of that is provided below.

Option #1: Limited Liability Corporation (LLC)

Businesses run best when the point of accountability is clearly defined. A limited liability corporation puts the decision-making powers in the hands of a sole proprietor while offering the tax benefits of a corporation. This structure is most common for small business owners who don’t have plans to go public or issue stock to investors.  

An LLC is classified as a “pass-through entity” by the IRS, meaning that profits can flow through to the owner without a corporate tax liability. The owner of the LLC is required to fill out a Schedule C to declare business income and expenses. Those expenses are deducted from total revenue to determine the owner’s personal income for the year.

Forming an LLC is the simplest way to incorporate a business, but it comes with limitations. For example, you can’t issue company stock with a limited liability corporation. “Shareholders” are classified as “members.” They don’t need to make an investment to attain that status. The owner can simply grant them membership and allow them to share in the profits.

Option #2: Limited Partnership Agreement

A single-member LLC is controlled by one owner. A limited partnership agreement, which is also known as a limited liability partnership (LLP), changes that dynamic. Partners are assigned specific responsibilities and given a share of company profits. The personal tax liability for those profits is the responsibility of the partner. That’s defined in the partnership agreement.

Limited liability partnerships are pass-through entities like limited liability corporations. When filing taxes, the company needs to file a Schedule K-1 (Form 1065) declaring each partner’s share of partnership income, deductions, and credits. Hire an accountant to help with this. Partnerships run more efficiently when a third party handles the accounting and taxes.

Trust is the most important requirement for a partnership. Ironclad paperwork secures that trust. Having an attorney draft that paperwork can protect you from legal issues later. Add that to the list of things you need to do before choosing this business structure. You might also want to pick

Option #3: Incorporating as an S-Corp

The next level up from an LLC or LLP is an S-Corp. This is a business structure where the corporation can issue stock to shareholders. Owners are not personally responsible for the business tax liability; shareholders are taxed on the profits. That makes an S-Corp a good fit for smaller businesses looking to bring in up to one hundred investors.

Setting up an S-Corp is more complicated than simply filling out some paperwork. This business structure requires a board of directors and corporate meeting minutes. There are strict rules that govern how you do this, so it’s best to bring in a corporate compliance expert. You’ll want to select some experienced professionals for your board too.
Forming an S-Corp is more expensive than putting together a limited liability corporation. Legal Zoom charges $149 plus the state filing fee. A corporate lawyer will charge significantly more. Consider any costs incurred as an investment. If you provide the funds to get the process started, shareholders will provide the revenue to get you up and running.  

Option #4: Incorporating as a C-Corp

Owners of an S-Corp can only hold common stock, which gives them voting rights. Owners of a C-Corp can hold preferred stock which does not come with voting rights but does give them preference to dividends before common shareholders. This is a more complex structure than any of the others on this list, so make sure you have professional help setting it up.

C-Corps are the best option if you want to take your company public someday. They’re also recognized internationally, so shareholders don’t need to be US residents. A board of directors and corporate minutes will be required, along with the payment of corporate taxes. Obviously, you’ll need a team of legal and accounting professionals to help you with this.

Outside of tech startups, few companies start out as C-Corps. This is a level that you’ll want to work up to. Companies that launch as LLCs, partnerships, or S-Corps can always restructure if the opportunity arises to sell or go public. There are also some financial drawbacks to being a C-Corp. One of them is your ability to raise funds if you want to expand.  

How Your Business Structure Affects Funding

Venture capital firms prefer limited partnership agreements when they invest in a company. With a partnership, the ownership responsibilities and profit sharing are clearly defined. Stock is not public, and it can’t be diluted. If the venture capital firm is a partner, they have a say in the business operations of the company. That allows them to protect their investment.

Venture debt companies like Wise Venture don’t have the same limitations. You’re not required to surrender a piece of your company when you take on venture debt, so the business structure doesn’t matter to the lender. Of course, your board might have something to say if you’re an S-Corp or C-Corp. You’ll need to check with them before you take on any new debt.

Reread this article carefully before deciding which business structure is best for you. Our team is available for assistance if you need it. There are several online resources, including Investopedia, LegalZoom, and IRS.gov. You should also check with your accountant and your attorney to make sure you get the paperwork filed correctly.