Starting a Business – Choose Your Entity Wisely

Post by Mark W. Siler

A friend of mine recently lost his job and has been looking for new employment for several months without much success. This lack of success led him to explore the prospect of starting his own business. This idea has been in the back of his mind for quite some time, however, the comfort afforded him by his old job was too good to let go. With that comfort gone, he was now willing to take the risk that comes with starting a new business. He came to me and asked if I could help him set up an LLC to operate his business.  I asked him was why he had chosen an LLC. His response: the LLC is the easiest to set up. While an LLC is easy to form and is a useful entity, the assumption that the LLC is the proper entity in all cases can lead to difficulties for starting a business in the future.

Seemingly simple, choosing the correct business entity can be difficult without a clear idea of your business goals, and making the correct choice can be paramount to a new business’s success. While there is no simple checklist for determining which entity is best for a new business, having a clear vision of the short term and long term business goals will lead the new owner a long way to choosing the appropriate business entity.

A new business can be operated using several business entities including a sole proprietorship, a partnership, a limited liability company and a corporation (and within the corporation, you could choose a C or an S Corporation). Each entity has its own advantages and disadvantages and determining which is appropriate for a new business depends on the business the new owner plans to undertake.

When determining the appropriate entity for their businesses, new owners raise several common concerns. Which entity will provide the greatest protection from personal liability? How will I be paid? Which entity provides the best personal tax results? These are all important concerns; however, focusing on personal questions makes choosing an entity more difficult because the owner is not concentrating on business needs. More important than personal concerns are short and long term business goals. Understanding these business goals will generally lead to the proper entity choice.

To determine the short and long term goals for the new business, some issues to take into account are: what type of business is being operated? Is it an active business or a passive investment business (i.e. holding investment real estate)? Will the business be selling goods (or providing services)? Will all of the investors in the company manage the day-to-day operations of the business or will there be passive investors? Do the owners have an exit strategy or vision for the future? Is the owner attempting to avoid self-employment tax?

Understanding the short and long term goals of the business will help the new owner avoid the mistake of choosing an entity for personal reasons before taking into account the needs of the business. Rather than choosing and forming an entity to calm personal concerns, compile a list of short and long term visions for the business. Armed with that information, the new owner should consult with an attorney and allow him or her to help you make a final decision on the appropriate entity with a clear view of the specific needs of the business.

Disclaimer

The comments and opinions expressed in this blog are intended for informational purposes only and do not constitute legal advice. Reading or using the information in this blog does not create the existence of an attorney-client privilege. Due to the changing nature of the law, the blog posts may contain dated material. For an update on the current law and the application of the law to your particular facts and circumstances, consult a legal advisor. The information contained herein is not a substitute for obtaining legal advice from a qualified attorney licensed in your state.