Starting a business is a thrilling journey filled with excitement, innovation and the promise of potential success. However, choosing the wrong business structure to reach your objectives can set your business on a path to failure before it even gets started.

The Importance of Business Structure
The business structure you choose impacts every aspect of your startup, from how much you pay in taxes to your personal liability, from your ability to raise money to the amount of paperwork you need in order to do so. This decision should not be taken lightly and requires a thorough understanding of the implications. While the terms “LLC,” “Partnership,” “C-corp,” and “S-corp” are thrown around loosely, each entity comes with its unique rules, costs and benefits.

The Different Types of Business Structures
There are several types of business structures, each with its own advantages and disadvantages. The most common forms are sole proprietorship, partnership, corporation, S corporation, and Limited Liability Company (LLC).

• Sole proprietorship: This is the simplest form of business structure, where the business is owned and run directly by a single individual. It’s easy to set up as generally no corporate filings are necessary to establish a sole proprietorship. A sole proprietorship also gives the owner complete control over the business. On the flip side, a sole proprietorship means that the owner is personally liable for all the business’s debts, liabilities and obligations. For example, if a sole proprietorship enters into a contract with a customer, and the customer sues the sole proprietorship for a breach of that contract and wins the lawsuit, the owner would be personally on the hook to satisfy the damages awarded to the customer. The customer could reach into the owner’s personal assets to satisfy the judgment, such as the owner’s personal bank account, real estate or investments. In addition, it is nearly impossible to raise capital outside of personal guaranteed debt in this form of business structure.
• Partnership: This involves two or more people who share in the profits and losses of a business. Partnerships come in two main flavors: general partnerships and limited partnerships. A general partnership is easy to form—it only requires two people and an agreement to be partners—and generally does not require any formal corporate filings. The partners in a general partnership equally control the business. The downside of a general partnership is that, similar to a sole proprietorship, the partners’ liability is not limited. A creditor could reach into the personal assets of each partner to satisfy any liabilities, debts or obligations. A limited partnership is harder to form as it requires corporate filings in the state in which it is formed. A limited partnership has one general partner who controls the business and one or more limited partners who invest capital but have no control over the business. Like a general partnership, the general partner of a limited partnership is held personally liable for the business’s debts and obligations.
• Corporation: These are separate legal entities from their owners and are the preferred choice of entity for investors investing in startups. This means that the corporation itself, and not the shareholders of the corporation, is usually held legally liable for its actions and debts. To form a corporation, an incorporator must make a corporate filing with the state in which the corporation is to be formed. In addition, there are several laws that apply to corporations that shareholders must be aware of, including corporate laws related to board of director fiduciary duties and shareholder rights, and security laws related to the issuance of equity. Although corporations are subject to more laws and regulations, and cost more to upkeep than other entity types, they are the preferred legal entity choice for investors looking to invest in startups. Investors are comfortable with the clear evidence of equity ownership in a corporation, as well as the legal rights bestowed to shareholders of corporations. Corporations are typically taxed as “C Corps,” which subjects the corporation to tax on income and tax on dividends. Corporations can elect to be taxed as “S Corps,” which avoids double taxation on the corporate income, and passes the corporate income, losses, deductions and credits through to the corporation’s shareholders. If the corporation elects to be treated as an S Corp, it must make sure it remains in compliance with the rules around S Corps or it could potentially blow its S Corp election.
• Limited Liability Company (LLC): This is a hybrid structure that combines the simplicity of a partnership or sole proprietorship with the liability protection of a corporation. Owners of an LLC are called members, and the company can be owned by one or more members. LLCs are typically governed by a written agreement called the operating agreement or LLC agreement. This provides for great flexibility in management structures and member rights of an LLC. An LLC is formed by making a filing with the state in which the LLC is to be formed. An LLC has increasingly become accepted as a legal form that a growing number of investors in startups are willing to invest in. However, if your goal is to take your startup public, your entity will need to be converted into a corporation at some point. This involves several steps and corporate filings. An LLC can be taxed as a sole proprietorship, a partnership, a C Corp or an S Corp, depending on tax elections and characteristics of the entity’s ownership.

The Consequences of a Poor Choice
Choosing the wrong business structure can have serious consequences. For example, if you choose to operate as a sole proprietorship or a partnership, you could be held personally liable for the debts and obligations of the business. This means that if your business fails, your personal assets could be used to pay off its debts. In addition, it would be increasingly difficult for you to access venture capital and other forms of equity investments.

On the other hand, while corporations offer liability protection, they are more complex to set up and involve more regulations and tax requirements. If you’re not prepared to handle these complexities, you could find yourself in legal trouble or paying more in taxes and administrative costs than necessary.

The Bottom Line
Choosing the right business structure is crucial for the success of your startup. It’s not a decision to be made lightly or without proper advice. Consult with a business advisor or attorney to understand the implications of each business structure before making your choice. Remember, achieving your dreams could depend on it.

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