When starting a business, you have to make a ton of decisions. Deciding what to name your company and hiring employees, what kind of products or services you should sell, and how to fund your operation, getting your business off the ground comes with a nearly endless number of decisions.
Of all these decisions, perhaps none is more important or has a more significant impact on your success (or failure) than your choice of business entity structure. Indeed, the entity you choose for your business will affect everything from the amount of taxes you pay and what kind of records you are required to keep to how vulnerable your assets are to lawsuits incurred by your company.
Among the different business entities, all companies should be one of the following legal structures: a sole proprietorship, partnership, corporation, or limited liability company (LLC). While you should consult with a Family Business Lawyer™ before making your final decision, here are four of the leading factors to consider when selecting the entity that’s best suited for your particular business.
1. Number of Owners
The number of owners your business has will factor into the entity forms available to you to choose from. For example, if you own the business yourself, you can operate as a sole proprietorship, an LLC, or a corporation without any other partners. If you choose an LLC, its owners are called “members,” so you would operate as a single-member LLC. If you choose a corporation, the owners are “shareholders,” and you can be the sole shareholder of your corporation.
If your business has more than one owner, your choices of an entity include a partnership, an LLC, or a corporation. If you have multiple owners as an LLC, your company would be considered a multi-member LLC. Note: if your business has multiple owners, you MUST have a lawyer prepare your operating agreement or bylaws. Do NOT use a document service. Navigating ownership terms, transfer rights, what happens when a partner or shareholder wants out, and what happens at death all require consideration and custom decisions that cannot be addressed with a one-size-fits-all solution. If you do not have your multi-person business agreements documented by a lawyer, you risk massively expensive surprises down the road when you sell the business or when one of your owners dies or wants to get out of the business. Or when the business needs additional capital. So whatever entity type you choose, if you have a multi-owner structure, contact us to get your agreements in place.
2. Asset Protection
The second factor in your entity choice is protecting yourself from legal liability. In today’s highly litigious society, all businesses should prepare for legal conflict at some point. At a minimum, that conflict could be as simple as a refund request, or as complex as an employee or team member lawsuit, or worse. If you don’t have the proper entity in place, you could lose your home, vehicle, and even life savings to satisfy a judgment.
The same thing could happen if your company ever suffers a significant financial loss or goes out of business. Your company’s creditors could seize your personal assets to satisfy your business debt. This risk arises because unless you have the correct entity in place, there’s no separation between your business and personal assets, so your personal assets would be up for grabs in the event your company ever gets sued or goes into serious debt.
For example, suppose your company is a sole proprietorship or a partnership. In that case, you and the other owners are legally inseparable from your business—your business and its owners are the same in the eyes of the law. Therefore, you and the other owners would be personally liable for any debt or court judgment incurred by your company.
However, if you set up our business as either an LLC or a corporation, you can shield your personal assets from your company’s legal liabilities, including lawsuits and debt. When correctly set up and maintained, these two structures establish your company as a separate legal entity that’s distinct from you and the other owners as individuals, preventing you from being held personally liable for the company’s debt or legal disputes.
A Family Business Lawyer™ can not only help you choose the correct entity for your business, but they can also support you in setting up and maintaining your entity to ensure you have maximum personal liability protection.
Next week, in part two, we’ll discuss the final factors to consider when choosing your business entity.