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What type of entity should a small business owner use?
This question is part of the Focus Finance Roundtable: Effective Tax Strategies for Small and Medium-Sized Businesses on January 6th, 2011.
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3 Answers
The laws of the state in which you establish your business and the particular situation will be the most significant factors in the type of entity you establish, but Limited Liability Corporations (LLC) and C Corporations are the best all-around options in my experience and opinion. Partnerships and sole-proprietorships come with too many hassles and too much liability, respectively. A C Corp is a lot more work than an LLC, but if you intend to grow your company to a significant size, potentially even go public, then a C Corp is the best option in my opinion. As always, consult with reputable lawyers, business accountants, and/or small business assistance organizations (there are many, government and private) to look at all of the factors and make the best choice for your situation.
We wrote an extensive post on this topic at capgenius.com. Given the 4,000 character limit I will include some of that article below, as well as a link to the post if you want to read more details. The article does not consider the S-Corp option as it has become less popular that the newer LLC structure. If the state you plan to incorporate in does not offer the LLC option, consider incorporating in a different state, we recommend Delaware.
Here is the link to the post: http://capgenius.com/2011/02/24/should-you-set-up-a-c-corporation-or-llc/
C-Corp: You are planning to raise outside capital from a group of investors, believe your company will grow to be a big business and potentially go public one day, or you’d prefer to have all taxation handled at the corporate level instead of passed thru to individual shareholders including yourself.
LLC: You expect your business to be smaller and not have as many shareholders, and to raise little (if any) outside capital. You do not expect to go public but think it is more likely you will want to pay the profits made by the company out to shareholders on a regular basis.
There is no one entity type that is a perfect fit for every small business. Some of the major factors in choosing the right type of entity are: what type of business, your long range plan for the business, length of time to turn a profit and your exit strategy.
Some businesses are restricted by state law as to type of entity. Law firms are a great example. Most if not all states do not allow law firms to be corporations.
If your startup will be showing losses for the first couple of years you would want to consider a type of entity that passes these losses to your individual return including LLC, S-Corp or Partnership.
Although from my experience the LLC is the flavor of the week there is no one type of entity that a prospective small business owner should choose. Do you homework, talk to a lawyer and CPA, weigh all the factors and then make your choice.
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