Starting a new business can be an exciting and rewarding endeavor. However, you need to make sure you organize your company with the legal structure that makes the most sense for your particular business. Not selecting the appropriate type of legal organization for your business can have crucial impact on the success of your business – and even on you, personally.
The most common legal entities for small businesses in New York State are Sole Proprietorships, Partnerships, Corporations and Limited Liability Companies (LLCs). The business entity that is best for you depends on the type of business you have, as well as your own personal financial situation. First, you need to consider the amount of paperwork that’s required (and the associated fees) upfront, as well as ongoing recordkeeping. You also need to consider how the liability of the owners should be handled, and whether you want to keep a clear separation of business and personal liability when it comes to financial and legal issues. Raising working capital can also be very important to the success of your business, and differs greatly depending on which business structure you have. Finally, you need to consider everyone’s favorite subject: taxes.
Required Paperwork and Recordkeeping
A Sole Proprietorship does not have to be registered with the State of New York as a Corporation – meaning it is “unincorporated”. It is simply you doing business as the sole “owner” of your business. In the eyes of the law there is no distinction between you and your business. A Partnership is very similar – except that you are doing business with one or more “partners”. Like Sole Proprietorships, a Partnership is not incorporated or registered as such with the state. Both of these legal entities require the least amount of paperwork and initial startup fees, and the least amount of ongoing recordkeeping. A Limited Liability Company (LLC) requires additional paperwork, registration with the state, more extensive ongoing recordkeeping, and is subject to some special operating rules. However, the paperwork, fees and recordkeeping requirements are not as extensive as a full Corporation.
Liability of the Owners
As an owner of a Sole Proprietorship or Partnership, you personally take on full responsibility for your business. Basically, the State doesn’t sees any separation between you and your business in legal terms. This means that you are personally responsible for any debt that your business acquires, or any legal claims made against your business. Collectors can come after your personal assets in order to satisfy claims against your business or debts incurred by your business. In contrast, both LLCs and Corporations provide “limited” protection; these business entities shield your personal assets from claims made against your business.
Ability of the Company to Raise Money
You have a limited avenues in which to raise money for your business if you operate under a Sole Proprietorship or Partnership structure. With an LLC, you may find it easier to establish business lines of credit. However, you still cannot sell shares or offer stock options. If you foresee that to be a viable way of raising capital and attracting top caliber talent, you will need to establish a Corporation.
Because the state does not make a legal distinction between your personal income and your Sole Proprietorship or Partnership, you are required to include all net gains or losses when you submit your personal income tax. With a Corporation, you are only required to recognize the salary you pay yourself on your personal income tax (however, you are required to pay yourself a “reasonable” salary). The remaining net gains and losses are then subject to tax on the corporate level. While this does increase the complexity for filing, you may be able to recognize signification overall savings on the amount of tax you’re required to pay since corporations are taxed at a lower rate within certain brackets. If you operate under a LLC structure, you have the flexibility to elect how you wish to be classified for federal tax purposes: either as a Sole Proprietorship/Partnership or as a Corporation.
Which Structure is Right for My Company?
If you have limited funds as you start your company, and you’re willing to personally take on the financial risk associated with your business, a Sole Proprietorship or Partnership might be right for you. They both require little paperwork and fees upfront, and the required record keeping is much simpler to manage over time. You can also change your business structure to an LLC or Corporation at a later date when your company becomes more established or you take on more financial risks.
If you do want to shield your personal assets from your business endeavors from the start, an LLC often is the best option. It provides the limited liability of a full corporation without the full extent of paperwork and fees required to incorporate. LLCs are becoming increasing popular with entrepreneurs, and many successful companies operate under this structure today. A Corporation does provide the additional benefit of stock options and potential tax savings; just don’t underestimate the amount of recordkeeping and the time and commitment that requires. Corporations are also much easier to “sell” or transfer ownership.
All of these considerations need to be weighed carefully and can help lead you and your business to financial success or financial struggles. This article just touches briefly on some the major differences between the most common business structures in New York State. To learn more about what legal entity may be best for your company and your situation, contact Lawrence Baker, Esq. – a Rochester, NY attorney with a specialty in Business and Finance Law.