Choosing the right structure for your startup

You'll need to decide on a structure for your startup, and the structure you choose could have big implications for tax and liability
Edward Kost @EdwardKost
Technical Co-pilot
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Before you start establishing your business you need to decide on its structure

Your choice of business structure depends on the multiple variables: how many people will run the company, how much liability you're willing to put on the line, etc.

It can get quite confusing and overwhelming. The good news is that you have the option of changing your structure as your business evolves, so there's no need to worry about locking yourself into a bad decision.

Choosing the wrong business structure, however, could result in you paying a lot more taxes and risking a lot more of your assets, so you should do the best you can to select the right structure from the get-go.

In this chapter, we'll detangle the confusion of business structures and help you choose the perfect one for your startup

Types of business structures

There are 7 main types of business structures in the United States. These structures are applicable to both brick and mortar businesses and ecommerce businesses:

  1. Sole Proprietorships

  2. Partnerships

  3. Limited Liability Company (LLC)

  4. C-corp

  5. S corp

  6. B-corp

  7. Nonprofit

Sole Proprietorships 

sole proprietor business structure

A sole proprietorship is the simplest business structure. It’s the standard structure of all solopreneurs for a good reason: the setup process is very quick.

When you operate as a sole proprietor, you and your business are both one entity. This means that you share the same income as well as the same assets. This does come with some implications we'll discuss in more detail shortly.

If you're starting your business alone, a sole proprietorship is a good structure to choose. Almost all businesses begin as a sole proprietorship and then evolve intro more complex structures over time if required. 

There are several reasons a business owner might choose to upgrade from a sole proprietorship:

  • To reduce liability and therefore mitigate risk

  • To increase chances of securing funding (from banks and investors)

  • To split a venture with other partners

  • To keep business tax separate from personal tax

We'll expound upon some of these reasons below: 

Advantages of choosing Sole Proprietorship

Advantage 1: Quick setup

sole proprietor advantage quick setup

There are very few setup requirements for a sole proprietorship. If you wanted to stay as lean as possible, you could run a sole proprietorship under your name only without registering a business name.

Other businesses structures require the payment of a registration fee in order to get set up. Sole proprietors, however, don't have any registrations fees (although other fees may apply).

Advantage 2: Uninhibited decision making 

Sole proprietor advantage uninhibited decision making

If you run a business as a sole proprietor you don't have anyone else to answer to. No business partners. No investors. Just you and your vision.

This advantage is the main reason why business owners prefer to keep this structure. If you prefer to be the only captain steering your ship, a sole proprietorship setup is ideal.

Advantage 3: Simpler and cheaper tax returns

sole proprietor advantage simpler and cheaper tax returns

Of all the business structures, tax returns for a sole proprietorship are the simplest to file. As a result many solopreneurs prefer to file their own tax returns, at least in the early stages of establishment before things get too complicated.

Because a sole proprietorship and its owner are considered a single entity, only one tax return is required. The only extra requirement is appending a completed schedule C form to your tax return (more details on tax further along this document). 

The simplicity of sole proprietorship tax returns also means that there's no need to regularly hire auditors to assess your financial activity. This alone could save you thousands of dollars every year!

Advantage 4: More money for you

sole proprietor advantage more money for you

Because you're the sole owner of the business, you're free to decide on your salary. You're under no obligation to set aside a certain amount towards other areas of the business.

It is, of course, always wise to set security savings aside, but if you really wanted to you could legally take all of the after-tax profits!

Advantage 5: Easy to dissolve

sole proprietor advantage easy to dissolve

If for whatever reason you decide that running a business is just not for you, as a sole proprietor you can readily dissolve your operations in just a few steps.

The steps involved in dissolving a sole proprietorship vary from state to state, but the basic requirements are as follows:

  • Notify the IRS

  • Cancel any state obligated business licenses

  • Pay outstanding debts (make sure you collect all money owed to you first)

Disadvantages of choosing sole proprietorship

Disadvantage 1: Decreased chances of funding 

sole proprietor disadvantage decreased chances of funding

In order for banks to offer you a loan, they need to be satisfied that you have sufficient assets to cover the value of the loan in case of any problems with repayments.

If you operate as a sole proprietor, even if you do have sufficient asset security to cover the loan, those assets are at risk of being removed if you happen to be sued without any protective measures in place.

As a result, banks would of course feel hesitant about offering a sole proprietor a loan. 

The stats below illustrate the loan approval rate of sole proprietors in comparison to other business structures:

sole proprietor loan approval rate

Figure 1: Source: fundera.com

Another reason why sole proprietors might sometimes face loan approval issues is that the structure doesn’t make a clear distinction between business income and the owners income.

More complex business structures such as an LLC, formally separate business income from that of the owner. Such a formal financial structure is more appealing to banks because it conveys a greater sense of discipline with less risk of loan repayment issues.

Investors are also a lot less likely to fund a sole proprietorship because they will not receive a formal share of the company in exchange for funding.

Disadvantage 2: Unable to split equity 

sole proprietor disadvantage unable to split equity

If you decide to take on a business partner, you will not be able to formally split ownership under a sole proprietorship structure.

If you start your business with a partner, you would need to choose a partnership business structure or higher.

This inability to split equity is what prevents many sole proprietorships from securing investor funding. Investors almost always want a slice of the pie in exchange for their investment.

Disadvantage 3: Greater risk 

sole proprietor disadvantage greater liability

The main disadvantage of a sole proprietor setup is that it poses the greatest risk to your possessions (and therefore your family).

If your business is sued for any reason, all of your possessions could be taken to cover losses.

It doesn't just have to just be triggered by a lawsuit. If you ever run into issues paying your bills, your personal bank accounts and credit cards are at risk of being legally tapped into in order to cover payments.

If payment difficulties push you to file for bankruptcy, you wouldn't be able to file for it under your business only.

Since as a sole proprietor you and your business are both considered one entity, a bankruptcy status for your business would equate to a bankruptcy status for you personally too.

This high level of risk is what drives some entrepreneurs to preference a business structure without any ties to their personal assets, such as a Limited Liability Company (LLC).

But don’t let this risk scare you and prevent you from choosing a sole proprietor structure.

If sole proprietors kept getting sued and losing all of their possessions they would not be such a predominant sector of the business market:

sole proprietor popularity

Figure 2 - Source: fundera.com

Even though, at this stage, choosing a sole proprietorship may seem scary, there are some steps you can take to greatly reduce these risks, thereby allowing you to still reap the benefits of this business structure.

How to lower your risk as a sole proprietor

  1. Segregate financial channels 

lower risk as sole proprietor segregate financial channels

A very simple yet effective method of demonstrating the separation of business funds from personal funds is by opening up a business bank account specifically devoted to receiving and saving business funds.

By choosing to have a separate bank account specifically for your business transactions you're demonstrating your mature fund management abilities which is a very appealing trait to financial institutions.

When choosing a business banking account, make sure you shop around for the best possible deal. Often these accounts come with some conditions, such as the number of monthly transactions, minimum opening balance, minimum monthly balance, etc.

If you want to further demonstrate the seriousness with which you'll treat your businesses funds, use accounting software to categorise all of your transactions.

  1. Get insured

lower risk as sole proprietor by getting insured

Purchasing business insurance should be a mandatory requirement for all sole proprietors.

There are different types of business insurance available, each one designed to cover a specific category of business activity.

The minimal insurance cover you should purchase as a sole proprietor depends on whether you plan to work alone or employ others to work with you. 

If you plan to work alone, then the minimum insurance cover your should purchase is general liability insurance.

If you plan to employ others, the minimum amount of cover you should purchase is workers compensation insurance and general liability insurance. 

General liability insurance covers any losses your clients may incur as a result of your involvement. Workers compensation insurance covers any injuries your employees may incur while working for you (slipping on site, carpal tunnel syndrome, hearing damage due to loud noises, etc).

Most states require employers to purchase workers compensation insurance before any employees are hired.

If you hire freelancers, however, you're not obligated to cover them with insurance because they're classified as self-employed.

So a great way of expanding your operations as a sole proprietor while keeping your overhead as low as possible is to hire freelancers to work for you.

Here's a list of other types of insurance you may want to purchase as a sole proprietor:

  • Product liability insuranceThis cover protects your from any damage or injury that may result from your products.

  • Disability insurance This cover is mandatory in some states. It covers employees for any injury or death, and as a result guarantees a portion of their wages to their specified recipients.

  • Employment practices liability insurance

Protects you from any discrimination claims by employes such as wrongful termination.

While having the right insurance does give you and your personal assets a significant amount of protection, if you want to totally remove any possibility of losing your assets, the safest option is to upgrade to a limited liability company structure (more on that later).

  1. Always use contracts

lower risk as sole proprietor by using contracts

Insurance protects you in case of a lawsuit. Contracts help prevent lawsuits from happening.

Before doing any work for anyone, make sure you both sign a contract so that both parties have a clear expectation of all duties.

A quick reference of the contract could be all that is required to quell a dispute, which will save you a tonne of money on legal costs.

If possible you should get an attorney to curate contracts for each of your client based activities, although there are services online that provide contractual templates you can edit.

An example of one such online service is offered by LawDepot.

  1. Get an Employee Identification Number

lower risk as sole proprietor by getting an Employee Identification Number

Unless you have employees, as a sole proprietor you are not required to have an employee identification number (EIN), but it's still a good idea to get one for security reasons.

Not only does an EIN make your business seem more established, but also, in some rare cases, you could apply for a bank loan using just your EIN, without needing to provide your social security number.

Should you choose a sole proprietor business structure?

If you are starting out alone and want to start transacting as a business ASAP, a sole proprietorship is a great structure to begin with.

As mentioned, you can always upgrade structures as your business expands. Just make sure you purchase the appropriate insurance policies to protect you and your assets.

Taxation forms for sole proprietorship

Taxation forms for sole proprietorship

Sole proprietors need to outline all of their profits and losses in the Schedule C form that can be accessed here. 

They also need to fill out a standard form 1040, which can be accessed here.

More information on the taxation obligations of sole properties can be read on the IRS website by clicking here. 

How to start a sole proprietor business 

The process of starting a sole proprietorship differs from state to state, so you'll need to do a bit of research on your state's specific requirements.

Below is a general overview of starting a sole proprietorship business:

  1. Get an EIN

If you'll be paying employees you need to have an employee identification number (EIN). It’s absolutely free to obtain one, so if a 3rd party is offering to get you one for a fee, it’s most probably a scam you should steer clear of.

For instructions from the IRS on applying for an EIN click here.

For an outline on how to legally operate a business with employees click here.

  1. Obtain relevant licenses and permits

Not all business operations are permitted in every location. Even if you plan to run your business from home, your local zoning may only permit certain types of activities. 

For a list of federal licenses and permits from the United States Business Administration click here.

For information about the zoning laws of your location click here.

  1. Register a business name

If you choose to operate your sole proprietorship under your full name, you can skip this step.

If, however, you prefer to operate under an official business name, you will need to register it so that you can legally run your business under that name.

Registering your business name also prevents anyone else from claiming it.

For details on how to register a business name click here.

If you want to take things a step further and own the legal rights to the name, you can trademark it. 

For information on how to trademark your business name click here.

Partnership structure

partnership business structure

If you want to start a business with one or more partners, a business partnership is the simplest business structure that can accommodate this.

The structure of a partnership is very similar to that of a sole proprietor in that you don't have a separate tax return and you have free access to all the after tax profits.

In a partnership, each partner’s personal assets are also tied to the business, but the level of liability of each partner depends on how much of the business they own. 

So the partners with the least percentage of ownership have the least liability risk.

General partnership

A general partnership structure equally distributes the unlimited liability of the business across all members. 

So each member is equally liable for any loss and damage as they would be in a sole proprietorship scenario.

Limited liability partnership

In a limited liability partnership, the personal assets of business owners are protected from business responsibilities.

What to include in your partnership agreement

The partnership agreement is the most important document you will need to create when formulating a partnership structure.

The partnership agreement is a formal agreement amongst all parties of how the business will be run and the percentage of ownership of each partner.

It is important to have all of these details clearly laid out for all partners to agree on before any business operations are undertaken.

If any conflicts arise between you and your partners, you will have this partnership to refer to as an objective source of truth. 

The structure of your agreement is entirely up to you. There are, however, some important details we recommend you include in your business partnership agreement to cover all the bases of a possible conflict.

  1. Title of your agreement 

title of partnership agreement

In order for your agreement to have relevant authority, you need to specify in the title who is bound to the agreement.

If your business is operating under a fictitious name, then the name of the business should be used.

For example, “prestige motors partnership agreement”

If you will not be operating under a fictitious business name, all the names of all parties involved should be specified in the title.

For example, the title “Smith and Wesson partnership agreement” is an aggregate of the surnames of the two parties involved in this partnership. 

  1. Division of ownership

partnership agreement division of ownership

Specify how much of the business each partner owns. The percentage can be determined by the amount each partner invests into business, or by the level of contribution each person has committed to.

The ownership percentage will govern the distribution of profits amongst members, this is something you need to clearly outline in your agreement.

In this section you can also specify the liability status of each member (general or limited).

  1. Responsibilities of each party

partnership agreement responsibilities of each party

Even though this may cause a bit of a content overlap with the division of ownership section, it is important to have a section in your agreement specifically devoted to outlining the key responsibilities of each party.

All partners are limited to their outlined responsibilities. They can help in other areas too. Think of  these responsibilities as what is least expected of all parties.

  1. Decision making process

partnership agreement decision making process

The method of settling on a final decision should be clearly defined in your partnership agreement.

Maybe the individual with the majority ownership of the business will make the final decision for the company. 

Or perhaps a unanimous agreement amongst all members will be required before a final decision is made.

Whatever you decide your decision making process to be, each member should be satisfied with it prior to signing the document.

  1. Dispute resolution process

partnership agreement dispute resolution process

Whenever multiple parties are gathered together for considerable lengths of time, disputes are likely to occur, especially when it comes to establishing a business.

In order to keep all disputes civilised (and minimal), you should stipulate a mediation clause.

The method of resolution depends upon what works best for everyone. Maybe you can nominate a professional third party to formally mediate your disputes for you.

The end goal of a mediation clause it to prevent any disputes escalating to a court case.

This possibility should highlight the integral importance of only choosing business partners that work well together in all circumstances.

So choose your partners wisely from the very start!

For a helpful video about how to choose the right business partner Click Here

  1. Binding authority

partnership agreement binding authority

In order for anyone to sign an agreement on behalf of a business, they need to have the appropriate level of binding authority assigned to them.

This is probably one of the most crucial elements you need to make crystal clear in your partnership agreement - who has the right to officially represent the business?

If an individual with poor judgment is given binding authority, they can agree to sign up for a loan or service that may not be in the best interest of the business.

Once a 3rd party contract is signed it cannot be revoked outside of its terms and conditions, so take each member of your partnership into careful consideration when deciding whether they should be granted binding authority.

Specify terms to outline the appropriate process of executing the signing of 3rd party contracts and agreements.

  1. Death and withdrawal procedure

partnership agreement death and withdrawal procedure

You need a plan in place should any of your partners withdraw from the business either voluntarily or due to unforeseen circumstances such as death.

A buy and sell agreement is commonly put in place to settle such circumstances. The purpose of this agreement is to protect company shares from being sold to 3rd parties.

Usually, upon the withdrawal of a business partner, their portion of the shares are sold back into the business to keep all ownership distributed between the original remaining partners.

When curating your death and withdrawal clause, make sure you keep the business’ best interests in mind. Also keep it as clear and concise as possible. Following this procedure during such tough circumstances should be a straightforward process.

An important attribute of a partnership to keep in mind is that if any of its members pass away or withdraw, the business usually ends almost immediately. This is the downside of operating an entity that is inseparable from its members.

The same applies to sole propiertorships.

If this occurs, a new partnership would need to be formed comprising the updated list of members. 

Advantages of a partnership structure

If you're planning to start a business with multiple parties it may be tempting to settle with a partnership structure due to its simplicity. Make sure you read through the points below before making a decision: 

Advantage 1: Quick to implement

partnership structure advantage quick to implement

Just like a sole proprietorship, partnership structures are reasonably quick to implement. There's a lot less paperwork involved compared to other, more complex structures.

The only document that will demand a majority of your time is the partnership agreement.

Advantage 2: Uninhibited access to profits

partnership structure advantage uninhibited access to profits

Just like a sole proprietorship, a business partnership structure, all parties have access to as much of the business profits as they please, within their designated percentage share.

But just like with sole proprietorships, it's always a good idea to be conserviative when accessing profits by keeping the business savings account as hearty as possible.  

Advantage 3: Partners share debt burden

partnership advantage partners share debt burden

In a partnership structure, each member bears the burden of any losses and debts that the business may encounter.

This makes the prospect of high liability much less scary in comparison to a sole proprietorship.

Just be sure to outline the details of this shared obligation in your partnership agreement just to be absolutely certain that there will be no contention. 

Advantage 4: You have the support of others.

partnership advantage you have the support of others

The life of an entrepreneur can get very lonely. It's difficult to find people who are always supporting you and encouraging you to persevere beyond the temporary troubles you encounter on your journey.

While your family can provide you with support at times when you need it, they will never truly understand the day-to-day struggles you face. There's nothing quite like a supportive network on the inside.

Working together with partners also means you can share the workload of establishing a business.

This places a lot less pressure on you and makes the monumental task seem a lot more achievable.

Disadvantages of a partnership structure

Disadvantage 1: High liability

partnership structure disadvantage High liability

Even though the burden of any liability is distributed among all partners, you could still suffer extensive personal losses if your business goes under.

This risk could be mitigated with the implementation of appropriate insurance policies. The insurance policies we suggested for sole proprietors can also be used by partnerships.

Disadvantage 2: Decreased chances of funding

partnership structure disadvantage decreased chances of funding

Sole proprietorships and partnerships share the same disadvantage when it comes to both financial funding and investor funding.

Banks may find the unlimited liability component a risk to their loan security and investors might be reluctant to invest in an entity that cannot supply them with a formal share document.

Disadvantage 3: Limited liability partners have little jurisdiction.

partnership structure disadvantage limited liability partners have little jurisdiction

As tempting as it might be to settle for a limited liability status, these members have little authority to make decisions.

If you want the benefits of a business partnership without any restrictions, you would need to take the necessary risks of a general liability partnership.

Disadvantage 4: Limited life

partnership structure disadvantage limited life

Should any of the members of the partnership die or withdraw, a new partnership will need to be formed comprising the remaining members.

Should you choose a partnership structure?

If you want to run a business with at least one other person and get started ASAP with very low on-boarding costs, a partnership structure is a great choice.

If you decide to pursue investor funding or a bank loan, you can always upgrade to a more complex business structure.

If you're not certain about which structure is right for you and your business partners, settling for a partnership structure will give you the initial momentum to get started on your venture while you decide.

Tax details for partnership structure

For a detailed list of all the taxation obligations of business partnerships click here.

How to start a partnership business

The process of starting a partnership business differs from state to state. Do some research to find your state's specific requirements.

Here's a general overview of the process

  1. Get an EIN

If you'll be paying employees you need to have an employee identification number (EIN). It’s absolutely free to obtain one, so if a 3rd party is offering to get you one for a fee, it’s most probably a scam you should steer clear of.

For instructions from the IRS on applying for an EIN click here.

For an outline on how to legally operate a business with employees cclick here.

  1. Register your business with your state. 

This is usually done through your secretary of state office.

  1. Register your business your business name. 

Unless you want to transact under the official registered names of all partners, you need to register a fictitious name for your business.

For details on how to register a fictitious business name click here.

If you want to take things a step further and own the legal rights to the name you can trademark it. 

For information on how to trademark your business name click here.

  1. Obtain required licenses and permits

Not all business operations are permitted in every location. Even if you plan to run your business from home, your local zoning may only allow permit certain types of activities. 

For a list of federal licenses and permits from the United States Business Administration click here.

For information about the zoning laws of your location click here.

Limited liability company (LLC)

Limited liability company (LLC)

If you want to completely separate your personal assets from your business security, a limited liability company is the safest option to choose.

An LLC is the simplest structure that achieves an incorporated status. All other variations of corporations are also incorporated companies.

WIth this structure, the income of the business is flowed through to the owners and investors of the business. The benefit of this is that only one tax return needs to be filed by each beneficiary. 

This type of income flow is characteristic of "flow-through entities." Sole proprietorships and partnerships are both flow-through entities.

Advantages of an LLC structure

Advantage 1: Superior asset protection

LLC advantage superior asset protection

If a sole proprietorship or a partnership is sued, the business owners are liable to pay for any losses out of their own pockets. If these business owners don't have the money to pay the debts, their personal assets can be legally seized in order to make restitution for these losses.

An LLC business structure protects the personal assets of business owners in such circumstances.

This protection, however, is not only limited to your personal assets. In fact, an LLC structure offers the best protection for your business assets compared to all other business structures:

LLC structure provides superior protection to assets

Figure 3 - source: 1800company.com

As you can see from the graph, higher business structures overlook business asset protection. 

This oversight inspired the creation of the LLC business structure.

Advantage 2: Simpler tax returns

LLC advantage simpler tax returns

Members are required to submit only one tax return so profits are only taxed once.

Advantage 3: You can start an LLC alone

LLC advantage you can start an LLC alone

You don't require multiple business partners in order to launch a limited liability company. You can be the only business owner if you wish.

Advantage 4: Lean startup costs

LLC advantage lean startup costs

Though the cost of establishing a limited liability company varies from state to state, these costs are relatively light and affordable.

The onboarding process is also very quick, so you could have an LLC up and running within a very short period of time.

Disadvantages of an LCC structure

Disadvantage 1: Negligence could lead to asset loss

Even though an LLC structure provides superior asset protection, this protection is forfeited if any negligence is detected.

Some examples of negligence are:

  • Using company funds for personal use

  • Engaging in fraudulent behavior

  • Not exercising proper control of the company

If you keep all your business practices above board, you should have nothing to worry about. So have a reliable accounting solution in place that stores an accurate record of all business transactions and details of how they relate to business operations.

And most importantly, keep all personal transactions separate from business transactions.

The act of proving a business owner guilty of negligence and bypassing the asset security measures of an LCC structure is known as “piercing the corporate veil.”

Disadvantage 2: Taxed as self-employed

Since all members of an LLC are classified as being self-employed, they're responsible for paying their own social security taxes and medicare taxes.

Disadvantage 3: Ongoing annual fees

There are ongoing annual fees that need to be paid in order to maintain an LLC.

The exact amount of these fees depends on the state you're opening your business in.

Disadvantage 4: Difficult to raise money

Just like sole properties and partnerships, LLC’s cannot issue shares to investors.

This makes it much more difficult to secure investor funding.

Disadvantage 5: Limited life

Since all members of an LLC are classified as being one entity with the business, if any of the members withdraw either willingly or due to death, the business is dissolved.

Should you choose a limited liability company (LLC)?

The possibility (as remote as it might be) of losing one’s possessions due to business negligence is what prompts many entrepreneurs to settle for an LLC business structure. 

If you want the peace of mind of knowing that your personal assets are always protected from your business liabilities, an LLC structure will give you that assurance.

Since an LLC structure also protects your business assets from personal lawsuits, it's one of the safest structures to choose if you plan on purchasing high value business assets such as homes, vehicles, machinery, etc. 

Tax details for an LLC structure

Usually for an LLC, business profits are only taxed on each member's personal tax return, so there is no corporate level of taxation.

Some states, however, treat LLC’s as a C-corp and tax at a corporate level as well as a personal level. It's recommended for you to check with state income tax agency to see if this is the case for you.

You can find your state income tax agency by clicking here.

Other states give you the privilege of choosing which entity you would like to file your tax return as.

To choose the entity you would like to be classified as when filing your tax return, you need to complete form 8832. 

After you've chosen a classification, you need to submit the appropriate tax return for that classification:

If you would like your LLC to submit a tax return as a sole proprietor, use form 1040. 

If you would like your LLC to submit a tax return as a partnership, use form 1065.

If you would like your LLC to submit a tax return as a corporation, use form 1120.

If your state allows it, you could request an S-corp taxation status for your LLC. To check if this is a possibility contact your state taxation agency.

If you're permitted to set your classification as an S-corp you'll need to use form 2553.

How to start an LLC business

The process of starting an LLC business differs from state to state, so you'll need to research your state's requirements.

Here's a general high-level overview:

  1. Register a business name

For details on how to register a fictitious business name click here.

When registering your business name make sure you include the term "limited liability company" in the name.

The exact formatting of this phrase depends on the rules set by your state. For a summary of the LLC naming regulations of your state click here.

If you want to take things a step further and own the legal rights to the name you can trademark it. 

For information on how to trademark your business name click here.

  1. Get an EIN

If you'll be paying employees you need to have an employee identification number (EIN). It’s absolutely free to obtain one, so if a 3rd party is offering to get you one for a fee, it’s most probably a scam you should steer clear of.

For instructions from the IRS on applying for an EIN click here.

For an outline on how to legally operate a business with employees cclick here.

  1. Submit articles of operation

The document known as the "articles of operation" is a summary of your business operations and all the members of your LLC.

In most states you'll need to submit this document to your secretary of state.

  1. Complete an operating agreement 

If you'll be running your LLC with multiple members, it's recommended for you to complete an operating agreement.

This is not a mandatory requirement, although some states may request it.

This agreement is similar to the partnership agreement. It outlines the details of each member, meeting rules, decision making procedures and withdrawal procedures.

The format of an operating agreement depends on your State’s requirements. To download the operating agreement for your state click here.

  1. Obtain required licenses and permits

Not all business operations are permitted in every location. Even if you plan to run your business from home, your local zoning may only allow permit certain types of activities. 

For a list of federal licenses and permits from the United States Business Administration click here.

For information about the zoning laws of your location click here.

  1. Announce your business

In some states, all new LLC’s need to be announced in the public registry (newspapers etc).

To check if this is a requirement in your area, you should contact your district office. To find your nearest office click here.

Corporations

There are four different types of corporations : C-corp, S-corp, B-corp and nonprofit.

C-corp

c-corp business structure

A C-corp protects the liabilities of its members by standing as its own legal entity. This means that only the corporation is held liable for any losses.

This also means that C-corp members are often taxed twice, once at the corporate level and a second time when each member submits a personal tax return.

The main benefit of a C-corp structure is its ability to legally distribute shares to investors, which makes funding much simpler to obtain than it is for the lower business structures.

Advantages of a C-corporation

Advantage 1: Asset protection

C-corporations (as well as all the other corporation types below) offer a superior level of personal asset protection in the instance of a lawsuit.

LCC structures provide superior business asset protection compared to c-corp structures.

Advantage 2: Easier to secure funding

Since corporations can issue a legal share certificate to their investors, it's much easier to secure funding with these structures.

Their formal structure and separation of company cash flow from member cash flow also makes corporations much more likely to get approved for bank loans.

Advantage 3: Owners are separate entities to the company 

Such clear segregation is what keeps personal assets safe from business liabilities.

Advantage 4: Unlimited life

Since corporations are categorized as independent entities from their members, if any of its owners withdraw or die the company will still remain in operation.

The restructuring of management is a much smoother operation under an incorporated structure.

Disadvantages of a C-corporation

Disadvantage 1: Complicated on-boarding process

The on-boarding process of corporations can be quite overwhelming. Members need to provide highly detailed reports about the structure of the prospective company.

Some examples of the types of details required in these reports are:

  • Comprehensive break down of share distribution amongst members

  • Board of directors

  • Official corporate strategy

  • Schedule of formal meetings for shareholders

  • Formal decision making process for all major scenarios

This is only a concise summary, but you can see how this process will take some time to execute.

Choosing a business structure that protects both your personal and business assets comes with a catch: a lot more paperwork!

Disadvantage 2: Twice the tax 

This is probably the main drawback of C-corp structures. Members are taxed twice, once at the corporate level and again at a personal level after receiving profit dividends.

This disadvantage is what makes an S-corporation a much more appealing option when choosing an incorporated entity.

Disadvantage 3: Expensive

C-corporations are expensive to establish. The cost varies at a state level, you could find yourself paying $1,000 or more.

Paying an onboarding fee will not be the only puncture on your wallet. To keep your corporation registered you need to pay ongoing annual costs.

S-corp

s-corp business structure

This variation of the corporate structure was put in place to bypass the double taxation issue. 

An S-corp can operate as a flow-through entity in that profits are funneled straight to its members without suffering a corporate tax.

Unfortunately some states do not recognize the tax advantages of S-corps and tax these entities as a C-corp.

To learn more about the tax obligations of S-corps in your state click here.

Not everyone can choose an S-corp structure. The IRS has laid out a specific set of requirements that must be met before submitting an application for this business type.

Some of these requirements are listed below:

  • Shareholders must be U.S citizens.

  • No more than 100 shareholders.

  • Not be categorised as an ineligible entity, such as a financial institution, insurance companies and a domestic international sales company. 

B-corp

b-corp business structure

A B-corp (benefit corporation) is a for-profit version of a non-profit. B-corporations operate on a for-profit basis while at the same time exercising a charitable outreach. 

So if you have a charitable heart and you want access to company profits, a benefit corporation structure is a great option.

B-corps are taxed in the same away as C-corps, but with the added burden of releasing an annual report summarising how social obligations were met.

So in other words, B-corp members are often taxed twice and have more ongoing paperwork. 

But it's all worth it for the satisfaction of knowing that your personal pursuit of profits actually helps those in need.

Advantages of a B-corporation

Advantage 1: Personal satisfaction 

Benefit corporations are a powerful example of how much change the corporate would could achieve if a portion of its profits was shared with those who need it most.

The personal satisfaction B-corp owners feel when they see firsthand how those in need have benefited from their efforts is sometimes a lot more rewarding than seeing profit margins rise.

Advantage 2: A sense of community

When you start a B-corp you join a community of like-minded businesses owners who are also on a mission of a difference while making a profit.

B-lab is the certifying body that regulates benefit corporations and also encourages collaboration and inspiration between b-corp companies. 

B-lab regularly hosts events that being all B-corps together, so if you decide to strengthen your efforts via a partnership, these events are specifically designed to facilitate such endeavors. 

Advantage 3: More media exposure and more customers

A major benefit of being a B-corp is that others want to hear about your charitable activities. This can lead to a high number of interview requests and public relations opportunities.

Increased exposure will lead to increased revenue as prospective customers become aware of your solution and decide to purchase it because of the greater good their money is contributing towards.

This is an advantage your business will have over your competitors. If a customer has the choice of purchasing the same product from a competitor that isn't a B-corp, they're more likely to choose you because of your charitable impact.

Disadvantages of a B-corporation

Disadvantage 1: Taxed twice

Benefit corporations are taxed the same way that c-corpoations are taxed, both at a corporate level and again at the personal level when you receive company profits.

Disadvantage 2: More paperwork

B-corps are required to complete a benefit report to inform the public of all of their charitable activities performed in that particular year.

These reports also serve as proof that an organization is meeting the statutory requirements of a benefit corporation.

Should you choose a corporation structure?

There are many variations of corporations, each of them fall under the main category of an incorporated company,

In general, your business structure decision should gravitate towards the incorporated options if:

  • You foresee your business possibly being sued for personal injury or financial losses.

  • You want to raise investor funding

  • You plan on eventually selling your company or "going public"

The finer details of the specific type of incorporated entity you choose (C-corp, S-corp, B-corp and nonprofit), depends on how your unique situation measures up against the above list of advantages and disadvantages.

For obvious taxation reasons, an S-corp is the most appealing choice of all. Non-profits only have one option to choose from.

Tax details for a corporation

For taxation details of corporations structures click here.

How to start a corporation

Each state has its own procedures for forming a corporation, which you can find with a bit of research.

Below is a high level overview of the process

  1. Choose a business name 

Your corporation name needs to end with “incorporated limited” or “corporation.” Contact your secretary of state's office for the exact naming convention for your state.

  1. Submit articles of operation

The submission of this report to your secretary of state officially documents the formation of your corporation.

All the necessary details that describe the structure of your company are included in this report, such as corporate structure type, list of directors, share distribution details, etc.

You should also include a shareholders agreement, which specifies how the management structure is to be restructured in the event of withdrawal, buy-out, sale, etc. 

  1. Obtain required licenses and permits

Not all business operations are permitted in every location. Even if you plan to run your business from home, your local zoning may only allow permit certain types of activities. 

For a list of federal licenses and permits from the United States Business Administration click here.

For information about the zoning laws of your location click here.

Nonprofit business structures

Nonprofit business structure

The primary goal of a nonprofit organization is to benefit the public through charitable work. As the name suggests, nonprofits are not driven by profits.

In a conventional business structure, all profits can be funneled to members. In a nonprofit structure, all profits must be funneled back into the company to further fuel its work.

Nonprofits are eligible to receive a tax exemption (such as sales tax), although they are still required to pay employment taxes.

Even after a nonprofit is instituted, there are extensive reports that need to be created every year to clearly demonstrate how the company has used its profits to fuel its core charitable operations.

A major violation of a nonprofit status is the distribution of company profits to its members. Members can receive a set wage, but they cannot compliment these wages with a bonus sourced from company profits. 

Advantages of a nonprofit

Advantage 1: Personal satisfaction 

Just like benefit corporations, nonprofit owners have the satisfaction of knowing that their corporate efforts are resulting in the needy being helped.

Advantage 2: Less taxes

Nonprofits are exempt from income tax, so more of the money can be funneled back into the organization to further power its social impact.

Advantage 3: Eternal life

Nonprofits can still remain in operation even after their members withdraw. This seamless restructuring of management is one of the benefits of a business that’s classified as a separate entity to its members.

Advantage 4: Liability protection 

Owners of nonprofits are not personally liable to any debts or losses associated with the company.

Advantage 5: Grant eligibility  

Nonprofits are eligible to receive grants from the government to fund their operations.

Disadvantages of a nonprofit

Disadvantage 1: Costly and time-consuming start up

A lot of paperwork needs to be submitted in order to convince the IRS that your organization will be operating with a community-centric purpose and therefore should be exempt from taxes.

The cost of submitting a nonprofit application is also very high. Applications could cost up to $800.

Disadvantage 2: Difficult to get funding

There are limited grants available for nonprofits and almost every nonprofit in the country is competing for them, so the odds of securing one are not very high.

Besides grants, nonprofits can receive donations, but this does require ongoing marketing efforts to ensure that the donations keep rolling in.

But in order to maintain these marketing efforts, a nonprofit needs the funds to fuel them. This catch-22 is a difficult one that many nonprofits struggle to overcome.

Disadvantage 3: Strict yearly reporting

Just like B-corps, nonprofits are required to keep the public informed of their charitable efforts by releasing an annual report.

Anyone can scrutinise the operations of a nonprofit and demand to see a report of their activities at any time.

If you keep all of your efforts above board and maintain an up-to-date account of all your charitable activities, this shouldn’t be an unbearable burden.

Tax details for nonprofits

For nonprofit taxation information click here.

How to start a nonprofit

For the particular procedure of launching a nonprofit in your state, click here.

Business structure for ecommerce business

An ecommerce store is one that transact over the internet. You could have a brick and mortar store with an appended ecommerce store so that you can sell goods face-to-face as well as online.

Some online marketplace platforms (such as Shopify, eBay and Amazon) operate solely as an ecommerce business. These types of businesses are growing in popularity every year.

ecommerce growing trend

Figure 4 - source: shopify.com

As you can see, the ecommerce industry is well worth investing in.

But the hurdle that prevents most people from launching an ecommerce business is not knowing which business structure to choose for it.

It’s not as complicated as you might think. You can operate an ecommerce business with any of the structures outlined above.

If you wanted to get started ASAP you could launch a sole proprietorship or a partnership (if you want to work alongside partners).

If the goods or services you plan to sell pose a possible risk to consumers you should choose an incorporated structure in order to protect yourself and your belongings from all liabilities.

Some examples of high risk ecommerce products are:

  • Food items

  • Children's products (includes toys and clothing)

  • Exercise equipment

  • E-cigarettes and tobacco

  • Marijuana 

  • Online gaming

The inclusion of online gaming in this list may surprise you. How could that pose any risk to end users?

Gaming platforms are the targets of most cyber attacks. Cyber attackers can steal more than just user data. They can also deplete funds from digital wallets.

So if you plan on selling games online, it's a good idea to go for an incorporated structure.

Ecommerce business insurance

Ecommerce business insurance

That being said, it should be comforting to know that there are a range of insurance policies that have been created specifically for the ecommerce sector, so if you choose to operate as a sole proprietor or partnership you don't need to do so without any form of protection.

The below insurance policies cover the typical risks faced by an ecommerce business.

This list is intended to serve as a guide only. For professional insurance advice tailored to your specific situation, you should consult with a professional body such as a lawyer or insurance broker.

Cyber liability insurance & data breach insurance

This covers you in the event of any data breach. This is a must-have policy if you plan on selling software (including games).

Workers compensation insurance

Only applicable if you hire employees, not applicable if you hire freelancers instead.

Business interruption insurance

Insurance that covers unforeseen interruption to your business operations, such as a fire in your warehouse.

Electronic business interruption insurance

Covers loss due to interrupted to business operations that may result from a cyber hack.

Conclusion 

The structure you choose for your business depends on the level of risk your operations pose to your clients. If the threat of a possible lawsuit keeps you up at night, you should start with an LLC or a corporation structure.

The comforting thing about choosing a simple business structure is that you always have the option of upgrading at any time 

In the next chapter, we will discuss how to staff your startup from its infant stages straight through to maturity.

READ CHAPTER 5 OF THE ULTIMATE BUSINESS GUIDE

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