Small businesses are the backbone of the vibrant US economy: more than half of all registered business entities have fewer than five employees. Starting your own business can be a way to monetize a hobby, meet the needs of your community, or get started in a new industry or career.
Even small operations can take advantage of many federal, state, and local benefits. Different opportunities are available for each type of business entity. Before starting a business, you should explore the options that are available to you. What type of business structure you choose can impact your organization in many ways.
Small businesses are regulated by the state or states in which they do business. Because the laws regarding business formation are different from state to state, the types of business entities authorized by each state vary. Some of the terminology is also different. Common types of business entities include:
- Sole proprietorships
- Partnerships and limited partnerships (LPs)
- Limited liability companies (LLCs) and limited liability partnerships (LLPs)
- Professional limited partnerships (PLLPs) and professional limited liability companies (PLLCs)
- Nonprofit organizations
Sole Proprietorships and Partnerships
The simplest kind of business entity is a “sole proprietorship.” In most cases, you don’t need to do anything to establish yourself as a sole proprietorship other than to start doing business. However, you may need a license or permit to provide certain types of services or sell certain types of goods.
In a sole proprietorship, you are responsible for paying taxes on your income as well as self-employment taxes, although you may be able to offset some of your tax burden by deducting allowable expenses related to the business.
Alternately, partnerships are simple business structures among two or more individuals. As in a sole proprietorship, each partner is responsible for paying individual income taxes on their portion of the profits. Partnerships can be organized as a limited partnership (LP), which has one general partner and several limited liability partners, or as a limited liability partnership (LLP) for everyone involved.
Why Form an LLC?
A limited liability company (LLC) is a very basic type of business entity that allows its owner(s) to separate the financial assets and liabilities of the business from their personal finances. An LLC can have multiple owners (called “members”), which can be individuals, corporations, or other LLCs. Members have the discretion to manage the business’s operations and distribute any profits how they choose.
Besides limiting individual liability, the primary benefits of LLCs are that they:
- Have minimal formal requirements
- Are easy and relatively inexpensive to start
- Can quickly establish credibility for a new business
Most LLCs also can decide whether they wish to be treated as a pass-through business entity, an S-Corporation, or a C-Corporation for federal tax purposes. Before setting up your business as an LLC, you may wish to consult with an attorney or tax professional.
Choosing a C-Corp Business Structure
Individuals must pay taxes on their income to the federal government, most state governments, and some local governments. While there are certain deductions available, an individual’s tax burden generally correlates directly to a percentage of their income. On the other hand, a corporation can take advantage of many different deductions, accounting methods, and financial strategies to reduce its tax burden.
A corporation, or “C Corp,” is a legal business entity completely separate from any of its owners. Owners, managers, and decision-makers are generally insulated against personal liability for actions taken by the company. Corporations can issue shares, raise capital, and engage in other actions that aren’t available to LLCs or partnerships.
A corporation pays taxes as its own entity on its profits; if applicable, shareholders also pay taxes on corporate dividends. However, many corporations are eligible for tax incentives and exemptions that dramatically reduce their overall tax burden.
State and federal laws require companies to comply with many operational and record-keeping requirements. The costs to set up and maintain a corporation can be high, and there are also annual reporting requirements (and fees).
What Is an S Corp?
An S Corp is a tax classification that provides some of the advantages of an LLC and some of the benefits of a corporation. It’s not actually a different type of business entity; eligible companies can be organized as LLCs, partnerships, or closely-held corporations.
If the IRS approves a company’s request to be classified as an S Corp, the company itself will not be subject to federal taxes. Instead, its profits or losses will be reported by the individual members or shareholders.
What Is a Nonprofit Organization?
In general, the primary purpose of a nonprofit or not-for-profit business entity is to provide a collective, public, or social benefit rather than to make money for its owners. Qualified nonprofit and not-for-profit organizations are exempt from federal income taxes and may qualify for other benefits and incentives.
The rules for establishing a nonprofit or not-for-profit organization vary significantly from state to state. Most jurisdictions require a high degree of transparency in their operations, management, and accounting.
Five Things To Consider For Your Joint Venture Agreement
A joint venture can offer two or more businesses the opportunity to pool their resources and share their expertise to accomplish a particular objective. The manufacturer of a product might be presented with an opportunity to bid on a large contract requiring a substantial amount of raw materials. Purchasing the raw materials on the open market might require a huge expenditure of capital, so the manufacturer might approach the supplier with a proposal to combine their respective resources through a joint venture agreement.
The contents of a joint venture agreement will depend upon the facts and circumstances of the joint venture and the needs of the parties. Here are five things you might consider for inclusion in your joint venture agreement.
Be specific about the contribution each party is making to the joint venture
When two companies get together in a joint venture, each one might be contributing something other than money. The joint venture agreement should clearly state what is being contributed by each participant. For example, if one participant is supplying raw materials while the other party is going to manufacture a product from those materials, then the agreement should specify the amount of the raw materials that will be needed and to produce a specified number of items.
State how long the joint venture will last
The end of the joint venture might be stated by a date. Depending upon the circumstances, it might be better to state the termination of the venture by referring to fulfilling a certain number of orders or by some other quantifiable measure.
Specify the division of profits and losses
It should not be assumed that profits and losses are being divided according to the financial contribution of the parties to the joint venture. Make it clear in the joint venture agreement how each of the following will be divided:
- Management responsibilities
- Ownership of the products resulting from the joint venture
Anticipate problems before they arise
It’s easy to talk about making money and having a successful joint venture, but you also need to discuss what could go wrong and what will happen when it does. The joint venture agreement should have contingency plans written into it in the event any of the participants cannot perform their obligations.
Conflicts will happen, so cover their resolution in the agreement
Disagreements and conflicts will invariably arise during the course of even the most carefully negotiated and planned joint venture. When conflicts arise, the best thing for the parties and for the success of the venture is to resolve them quickly and efficiently. You might wish to include a mediation or arbitration clause in your joint venture agreement to avoid lawsuits or long, drawn out disputes that could jeopardize the success of the enterprise.
The success or failure of a joint venture can depend on the time and energy the parties put into their joint venture agreement. Anticipating problems that might arise and addressing them in the agreement is the key to a successful enterprise.
Starting a Business or Changing Your Business Structure?
Whether you’re just hanging out your shingle or you’re ready to take your small business to the next level, you’ll benefit from learning more about the many opportunities available in your area. Determine which business entity is best for you, learn the easiest way to set up your small business, browse information specific to your state, and find links to useful resources.