Starting a business is a dream for many aspiring entrepreneurs. Once you have raised sufficient capital, chosen an ideal location and ironed out other nitty-gritty’s, it is crucial to select a business structure that will enhance the operational and financial performance of your young enterprise. The structure you settle on will have various and tax and legal implications for your business.
Here are some of the factors you should consider when choosing a business structure.
1. First Things First
There are four main business structures:
- Sole proprietorship (trader) – Your own your business alone and manage it according to your wishes.
- Partnerships (general partnerships, limited partnerships & joint ventures) – You team up with other people to establish and run the business.
- Limited liability company (also known as private limited company outside the US) -- Works like a partnership, but you are not personally liable for debts of the business.
- Corporation (profit & nonprofit) – These a large organization with complex models and governance systems.
In this article, we are going to focus on the first three structures since corporations are not small businesses.
2. Start-up Capital
Many businesses around the world are sole proprietorships primarily because they don’t have huge startup costs. With as little as $100, you are good to start a small business. Therefore, if you have the capital to develop your businesses idea, you can establish a sole proprietorship. If you run into losses, you will have no one to blame or sue. Similarly, you will pocket all the profits.
On the other hand, if your business idea requires vast amounts of capital (say well over $50,000), teaming with one or more people makes it easier to raise the capital. The resulting structure will be a general partnership. You and your partners will also contribute labor and skills to the business, and profits and losses will be shared amongst yourselves. General partnerships are bound by general partnership agreements.
In general, sole proprietorships and general partnerships don’t need much legal paperwork. All you need to do is file business registration papers with your local authority and pay sales tax.
3. Legal and Financial Liability
Businesses can run into losses and shut down. If you want to protect yourself from losses, getting into a limited partnership may be best for you. A limited partnership comprises two or more people. You will sign a limited partnership agreement, and as the limited partner, you will have little management and decision-making responsibilities. As a result, you will be legally protected from any losses arising from the negligence or incompetence of your partners.
Limited liability companies are also suitable for entrepreneurs who want little legal and financial liabilities in the event a business collapses. To form an LLC, you will partner with other members, create an LLC agreement, and collectively appoint people to run the company. LLCs are highly tax efficient and are suitable for small businesses that have the potential to grow into corporations.
4. Nature of Business
In most cases, entrepreneurs focus on establishing businesses that will last for several years. However, some business are naturally short-term. If contractors are building a road in your area, for instance, you could start a business to supply them water throughout the period of the project. In this case, you can partner with other entrepreneurs to establish a joint venture. These ventures work like general partnerships, only that they last for a specific period of time.
To overcome various challenges, business goals are bound to change. As a sole proprietor, you have the full power to make changes to your business at any time. You can fire and hire at will.
Partnerships, however, will significantly limit your flexibility. You will need to consult with your partners and reach agreements. But we all know businesses people have different interests, so you may disagree on more than one occasion. This can hurt the business.
Finally, a new business, however small, should be given a solid foundation. As you start yours, it is advisable to seek the services of a business consultant, who can then analyze your business idea in detail and help you select an ideal structure.
If you have any question on starting a small businesses, feel free to ask in the comments section below.