You’re eager to get your new business off the ground and lay the groundwork for success. You’ve got a concept, a mission and the passion to make it happen. That’s the exciting part. But before you get too far ahead of yourself in terms of acquiring clients, rolling out your product or service and reaping returns, there’s a critical step that should never be overlooked: choosing your business’s legal entity.
Sure, this aspect of entrepreneurship may seem tedious and uninteresting — but if you fail to address it, you risk immense legal liability and jeopardize your own (and your family’s) financial well-being. This is one of the most hazardous decisions you can make as an entrepreneur.
As soon as you’ve resolved to start a business, you should determine whether the new company will be an LLC (Limited Liability Company), S-Corporation or C-Corporation. Under federal income tax laws, each of these have specific guidelines, so knowing which is right for you is key to setting up your business finances.
Yes, the details can be complicated. This is not always an easy or clear decision, as each option bears its own pros and cons depending on a number of factors that characterize your line of business and your goals for the future. Regardless, it’s a serious decision and one that you can’t afford to ignore or put off.
The Golden Rule: Don’t “Do Nothing”
It’s easy to become overwhelmed, confused and even bored by the options and details associated with choosing a structure for your business. Delving into tax implications or the technicalities of funding requirements and exit strategies may not be high on your list of inspiring business activities. But if there’s only one thing you take away from this article, let it be this:
The truth is it’s better to opt for the “wrong” legal entity than to fail in setting one up at all. Of course, the smartest path is to seek legal and financial counsel before choosing a business structure, but don’t underestimate the importance of taking action. And don’t make the mistake of relying on a sole proprietorship or a partnership, as neither of these options shields you from personal liability if the business cannot satisfy its liablities.
Without establishing a legal separation between you and your business, there’s no distinction between what’s at risk financially. Your personal assets are just as vulnerable as your business ones. In the event of a lawsuit, an employee injury or a loan default, you could be faced with companies, creditors or individuals coming after your house, your savings or your other financial valuables.
Understanding Your Options
Maybe you have some preconceived notions about the various categories of legal entities, or perhaps you don’t know have the slightest clue about any of them. Either way, it’s important to understand that you’re not choosing a legal entity based on the size of your company. The selection process should be structured around the following considerations:
- Fundraising Needs
- Administrative/Maintenance Costs
- Exit Strategies
Your optimal course of action is to consult with a legal and/or financial expert to discuss your business goals and requirements. An expert can help you pick the option that fits your business’s unique needs and protects you as an owner.
If you decide to get started on your own, however, there are some key indicators that you can use to make the most sound decision for your entrepreneurial journey. Keep these tips in mind as you prepare to make a final selection of legal entity:
- In most cases, it is best to start off as an LLC or S-Corporation because these are most suited to minimize your taxes early on AND provide legal protection.
- Think about whether you plan to raise money. If you do, an S-Corporation is likely to be your best bet. If you don’t, it’s more beneficial to form an LLC.
- It is very expensive to transition from an LLC to a C-Corporation, so if you have big fundraising goals for your business, look into the S-Corporation option. With this structure, you can more easily move the business to a C-Corporation when the time is right.
- When selling a company, it is better to be an LLC or S-Corp due to the single level tax.
Understanding the connection between business entity and legal liability is the first step toward minimizing your risks, and there is a wealth of information to consider in your selection process. To get a detailed breakdown of each legal entity, expert guidance on how to choose between them and straightforward direction on how to file, download our helpful e-book: The Entrepreneur’s Guide to Choosing a Legal Entity: How to Simplify the Process and Protect Your Financial Worth.