Login or signup
36
LEGAL ISSUES

What Kind of Business Are You Running?
 

As a budding entrepreneur, one of the first decisions you'll make is choosing your company's legal structure. And three letters like 'Inc.' can mean much more than a snappy moniker for your brand. Not only will this decision affect your ability to raise capital, it will impact the amount of tax dollars you pay, the personal liability you face, and the pile of paperwork you'll have to do. So before you launch your startup, try these on for size: Inc., LLC, partnership and sole proprietorship. This quiz will help you pick the best one for your business.
Advertisement

1. What do you plan to offer?

a. My own creative skills.

b. A business partner and I are pairing up to market our creative skills.

c. A product envisioned by me, but created by others.

2. Are you prepared to deal with some legal wrangling in order to get your business up and running?

a. I want to deal with lawyers as little as possible.

b. I'm willing to do a bit of legal work to get things moving.

c. I want to be able to provide strong dividends to my future shareholders, so I'm willing to work with the legal eagles to get my house in order.

3. Do you plan on enlisting the help of outside investors and venture capitalists to get the business up and running?

a. I plan on using my own money to fund my business.

b. I will be using outside investors, but mostly friends and family.

c. I will be actively seeking VC backing and sources of outside investment that are beyond my current circle of personal contacts.

4. How separate do you want your business and personal assets?

a. I'm all for putting everything on the line.

b. I'm alright with risking a bit of my personal nest-egg if it will benefit my business.

c. I don't want my personal assets to be on the hook for any of my business mistakes.

5. Bureaucracy, red tape, and excessive paperwork are …

a. The bane of civilization.

b. Irritating, but necessary to establish a structure and maintain order.

c. Essential. My team and I are masters at navigating bureaucracy and we don't mind the paperwork.

6. Taxes: how do you want to handle them?

a. It's simpler for all the money to flow into my personal return. I don't want to hire a raft of corporate attorneys for my small business.

b. As much as I would like to get corporate tax breaks on that money, my partners and I prefer the flexibility we gain from dividing up revenues and paying personal income taxes on them.

c. I'd prefer to have the company's revenue taxed at a separate, lower rate, because I'm going to reinvest that money in my business, anyway.

7. Will you and your partners have equal stakes in the company, or will responsibility be split up differently?

a. I won't have any partners – I plan to run my business entirely by myself.

b. I will be running the company with some associates and we will each have equal responsibility and decision making power. We'll have equal shares of risk and reward.

c. I plan to head the business myself but I will need a few other people to help make key decisions.

8. Do you plan on selling your stake in the company at any point?

a. No, I am in it for the long haul and will go where the company takes me.

b. Not sure, it depends on how things perform.

c. Yes, I am eager to get in and get out so I can pursue other opportunities.

9. Do you plan to take your company public?

a. Never! I want to remain entirely independent.

b. I just don't want to get sued and lose my house.

c. I want to go public ASAP.

10. Are you interested in fringe benefits?

a. Not really—I don't need too many taxable perks.

b. I just need tax-sheltered retirement programs and complete coverage of health insurance premiums.

c. Bonuses, corporate credit cards, and skyboxes galore.

Outcomes:

If you chose mostly As, you're probably looking to start a sole proprietorship. That means that you'll be making all of the decisions without having to answer to anyone, but that also means taking on a lot of responsibility.

First off, a sole proprietorship isn't a legal entity, so it's cheap and easy to set up. You will need the applicable business licenses to get started, but there are no other legal formalities required, making a sole proprietorship the simplest type of business structure.

If you are hoping to take on a partner or investors, a sole proprietorship is probably not the right move for you. You can always transition your business to a different entity later on, but you can't raise capital by selling a stake in the business and you can't issue stock, either. A sole proprietorship starts off simple but also stays simple.

But that simplicity comes with big risk, because you and your business are one and the same. You can mix your own money with your company's money, while LLCs and corporations cannot, but that also means that you (the owner) are personally responsible for all of the business's debts, losses, and liabilities.

If you chose mostly Bs, you might be either a partnership or an LLC. Here's how to decide.

In a partnership, like a sole proprietorship, the business is not separate from the owners' legal identities. This requires a very carefully constructed partnership agreement specifying the terms of dissolution. Because of the evenly divided responsibilities, disagreements can be a problem, and both partners are liable for each other's actions. But if you and your partner are teaming up to offer specific, complementary skills, such as law or design, this structure will serve you best.

If you chose mostly Bs, but a few Cs, consider an LLC, instead. It combines features of both a partnership and a corporation. It protects your personal assets from your company's debt and actions for which it is liable. It requires a little more legal work and planning to get off the ground, but it protects your nest egg from lawsuits or failure. As an LLC is a more independent identity, it's also easier to bring in new members, transfer ownership, and, eventually, take the company public.

But an LLC does not require the rigid, legally-mandated structure of a corporation, either, and it allows the simplicity of flow-through taxation. If you are looking for liability protection, but don't want to bother with the bureaucracy of a corporate structure, an LLC is the right structure for you.

If you chose mostly Cs, you should think about turning your venture into a corporation.

The loftier your goals, the more likely you'll be to choose a corporate route with your business. A corporation exists independently of its creators, so as shareholders, you and your business partners would only be responsible for your own investments in the event of failure. Because of a corporation's status as an independent entity, the company will also be easy to turn over to a new owner, should you choose to sell your venture in the future. If you're looking for outside capital, a corporate structure will make your company more attractive to investors, who will be able to purchase shares.

More paperwork and legal hurdles are involved with a corporation, however, than a sole proprietorship, a partnership, or even an LLC. Incorporating can involve significant licensing fees and high taxes, as its profits will be taxed both on a corporate level and when distributed to shareholders. You should always consult the services of an attorney, and you'll need to also appoint a board of directors.

Last updated: Nov 30, 2008




Register on Inc.com today to get full access to:
All articles  |  Magazine archives | Comment and share features
EMAIL
PASSWORD
EMAIL
FIRST NAME
LAST NAME
EMAIL
PASSWORD

Or sign up using: