Determining Your Business Structure

If you are thinking about starting a business, by now you’ve mulled over a business plan, thought about what will differentiate you in the market and may have toyed with the name. What many new business owners don’t realize is that one of the most important decisions they will make is the type of business structure that will be most beneficial for their company.

Here is a brief description of each type of structure and some things to consider. Please note that state laws vary in some respects to the following business structures, so it’s a good idea to discuss the following with your accountant or attorney.

Sole Proprietorship – the simplest structure. The business owner is self-employed and not taxed (except as an individual). You have more control because you are the lone decision maker, but your personal assets are exposed to business liabilities.

Limited Liability Company (“LLC”) – owners’ personal assets generally are shielded from business liabilities. Owners have the choice of being taxed like a partnership or a corporation. If the LLC has a single owner, the LLC can be taxed as an individual for federal purposes. An LLC is usually a good fit for a business that seeks liability protection, minimal formality and flexibility in governance and voting issues, as well as financial distribution issues.

LLCs often distinguish between “governance” (voting) rights/interests and “financial” rights/interests. For example, an LLC owner may hold a 25 percent governance (voting) interest but at the same time hold only a 15 percent financial interest. Some states, including Tennessee, recognize the existence and formation of “Professional Limited Liability Companies,” which encompass attorneys, accountants, architects and similar state “licensed” occupations.

Partnerships

• General Partnership – a voluntary contract between two or more people to start a business and share profits and losses. All owners are “general partners” and considered self-employed individuals. In addition to all assets of the partnership, all partners’ personal assets are at risk.
• Limited Partnership – similar to a General Partnership, except that Limited Partnerships will include at least one general partner (who generally “runs the show”) and any number of limited partners, who effectively want to limit their liability. As a practical matter, a limited partner generally has little control over the Limited Partnership and its business activities.
• Limited Liability Partnership (“LLP”) – similar to an LLC, except that a Limited Liability Partnership may not be taxed as a C Corp. LLPs are generally used by professionals such as accountants or attorneys. An LLP is a general partnership in which each individual partner remains liable for his or her own malpractice, as well as the liabilities arising from the wrongful acts or omissions of those they supervise. The increasing use of LLPs reflects changed perceptions of the traditional concepts of joint and several liability for large professional partnerships with hundreds of partners scattered over the country or even on different continents.

Corporations

• C Corp – a legal entity that exists separately from its owners. Owners are not considered self-employed, and shareholders own the equity. Ownership is, by and large, easily transferable, and there is limited liability for shareholders. Additional capital is easier to access through sale of stock. However, corporations can be complex and expensive to establish and maintain. They’re also subject to additional taxes that other business entities may not be required to pay. This structure may be ideal for a business that intends to attract investors through venture capital funding.
• S Corp – a standard business corporation with a special tax status. The S Corp can have no more than 100 shareholders, who are taxed like a partnership and have limited liability. Profits and losses pass directly through to the shareholders, and income is not taxed at the corporate level. All shareholders must be either individuals, banks, certain types of trusts or certain tax exempt organizations, and any individual shareholder must be a either a U.S. resident or U.S. citizen.

Making the right choice for your business will generally depend upon the type of business, how you want it to be run, how many owners it will have and the business’ financial situation.

Your business organization plan does not necessarily need to be set in stone. Often, businesses that start out as sole proprietorships or partnerships grow and convert to LLCs and corporations. If your business needs and plans change, your business structure likely can change with them.

Natalie Readett can be reached at (865) 766-3036 or natalie.readett@pnfp.com.