Changing your business structure is hard!
In order to answer the question “Do I need an LLC?”, there are many things to think about. Before choosing what form your business will take, you should carefully evaluate the options, and ask a lot of questions. What features of the different options are most important to you? Ease of operation? Administrative requirements? Tax implications?
A critical first question is, do you have business partners? If so, you definitely need a business structure. Even if you don’t have business partners, you still need a business structure.
Considerations
There are other things to consider. Do you need to protect your personal assets from liabilities of the company? Will the business seek venture capital funding? Do you want flexibility in the management and payment structures of the business? How big is the business? How big do you anticipate the business will grow, and how quickly?
The biggest benefit of any formal business entity is that it can protect the personal assets of the owners from liability of the company. On the other hand, the tax burdens and start-up costs might outweigh this benefit, particularly if you can effectively insure against liability.
Professionals may opt to not form a legal entity because professional malpractice insurance will cover the most likely claims. Owners of very small businesses may not have assets to protect, and for them the headache of business formation is not worth it.
The Options
There are many forms of business structure to chose from, such as:
- Sole Proprietorships & General Partnerships
- Limited Liability Companies
- S-Corporations
- LLC w/ S-Corp Tax Election
- C-Corporations
Let’s take a quick look at each of these options, beginning with sole proprietorships and general partnerships.
Sole Proprietorships/General Partnerships
“Sole Props”, as they are referred to in the industry, are the default if you start a business, are a single owner and don’t create any formal structure. If you are in business with other co-owners and have not created a formal business structure, you are in a general partnership. This is not the ideal.
Consider the following questions if you are thinking of being or are already in business with another person.
- Do you share a vision of the company, and future growth of the company?
- Have you agreed on how each of you will be paid, and an exit strategy if you don’t agree somewhere down the road?
- Is your agreement in writing?
- Do you have a similar business philosophy and work ethic?
- Have you agreed on division of responsibility?
- Who will make what decisions?
- How are disputes resolved and how will profits be shared?
- Is your partner’s capital investment in the business equivalent to your sweat equity, or vice-versa?
General Partnerships Can Cause Trouble
Partnerships have ruined many friendships, and should be entered into with care. The benefits include sharing the workload and risk, complementing each other’s skills and networks. Potential detriments include sharing profits, differing work ethics, disagreeing on business decisions, and negatively affecting your reputation.
Can you be a great partner?
The decision to partner is individual. Some people make great partners, some don’t. Will you be a great partner? Do you want to share the spotlight? Can you work with another person, and to come to agreeable decisions?
It is easier to start a business together than it is to dissolve a partnership that isn’t going well. Therefore it is important to clarify, in writing, the answers to these questions and many more.
Talk To Your Lawyer & Accountant
Consult with your lawyer and your accountant. They have worked with many business owners and have a good idea of what can happen, and how to forestall the worst consequences. An ounce of prevention is worth a pound of cure, as the saying goes, and it couldn’t be more true than in this context.
In addition to formation, dissolution, and the daily operations of the business, the tax implications need to be carefully considered. Self-employment tax is high, and if you are making or think you might make more than a specific annual cut-off, you will be responsible for estimated quarterly taxes, unemployment tax, and excise tax.
Do I Need An LLC? – Part II
Do I Need An LLC? – Part III
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