Forming a Business
Before opening the doors for your new business, careful considerations should be made to decide what type of business structure or entity is best for you. Both short-term and long-term goals should be considered when deciding. Sometimes the type of business itself will eliminate many of the possibilities.
Possible Business Structures-
Below, I outline some basic business structures along with some of their advantages and disadvantages.
Sole Proprietorship- This is where the business is owned and operated by you.
Advantages-
- Easy to form
- Least expensive to establish
- Minimal record keeping needed
- Taxed as an individual
- All profits (and losses) our yours
Disadvantages-
- Unlimited personal liability
- Death or illness can ruin the business
- Heavy responsibility on the owner
- Limited tax benefits
Partnership- This is where two or more people agree to owner and operate a business together.
Advantages-
- Easy to form
- More than 1 person to share responsibility
- Greater growth potential
Disadvantages-
- Unlimited personal liability
- Profits are shared among the partners
- Death or illness of 1 partner can ruin the business
- Lack of a written partnership agreement can cause a mess
Corporation- This is a separate legal entity from its owners.
Advantages-
- Limited liability for shareholders
- Easy to transfer ownership
- Unlimited growth potential
Disadvantages-
- More governmental regulations
- Possible double taxation
- More technical requirements
S-Corporation- A corporation where the profits or losses flow to the individual just like a sole proprietorship but with limited liability.
Advantages-
- Limited liability for shareholders
- Elimination of potential double taxation
Disadvantages-
- Can't have more than 10 shareholders
- Only one class of outstanding stock is allowed
Limited Liability Company (LLC)- This is a hybrid legal structure which combines some advantages of a corporation with a partnership.
Advantages-
- Limited liability for shareholders
- Losses can be used as deductions against active income
Disadvantages-
- Unanimous consent of shareholders needed to transfer
- Initial and annual filing fees with Illinois is more expensive than a corporation
Mark The Lawyer's Approach-
Educating a client is the number one way for them to make a decision that is best for them. Unless it is a type of business that has virtually no liability, I will caution against using a sole proprietorship. In this "sue happy" world we live in, personal liability is just too important to risk. Even with adequate insurance amounts, a catastrophic event can wipe out someone with unlimited personal liability.
Thus, we will usually look to some type of corporate or LLC structure to run the business. When comparing a S-Corporation vs. a LLC, I have compiled a detailed chart that I will evaluate with the client so that they can decide what is best for them.
Further, I will work with your accountant or tax adviser to ensure the best possible business structure for your tax situation.
A Word of Caution: Some (not many) accountants or tax advisers will tell you that they can set up a corporation or LLC for you "on the cheap". Be wary of that. At most, all they do is fill out the basic paperwork to be filed with the Secretary of State. That is not enough. Every time I have seen this, I will ask the person about the existence/maintenance of their corporate book or their operating agreement for their LLC. Invariably, they will reply "I don't have one". Don't put yourself in that situation. You are potentially blowing your limited liability status. Also, this has been construed to be the unauthorized practice of law in many jurisdictions.
Cost Factor-
The cost factor of establishing a corporation or LLC is small compared to the usual benefits. Generally, if you are small business start-up, setting up such entity will run around $750 (plus filing fees).If you have not done so, I encourage you to get a copy of my report titled:
5 Huge Mistakes People Make When Starting a New Business!