When you’re starting a new venture, there are a number of things to think through (and often stress about too), from the idea itself and how you’ll execute it, to the staff you might need to hire, money you might need to raise, marketing of the product and service, and so much more.
However, one area that tends to be rather confusing for many new entrepreneurs is that of corporate structure. There are a number of options to choose from, each with their own pros and cons.
When starting a new venture, you need to think about whether your organization should be set up as a sole trader, a partnership, a limited liability company – known as an LLC – or a corporation. When deciding, consider what will best suit your needs now as well as into the future.
Keen to get your head around the different types of structures available? Here’s some help.
The most simple and cheapest business structure to set up is a sole trader format. Sole traders are business owners/contractors who work independently and don’t need to hire staff members (or at least very few) to run the business. They work under their own personal name, or else choose a business name to use. Either way, all the expenses and income from the business simply go on the owner’s personal income tax return.
The major benefits of a sole trader corporate structure are that it’s quick and easy to set up, and at low cost. This makes it perfect for someone wanting to test the waters on a business idea, or a contractor who is happy working independently and who has no interest in turning the enterprise into something much larger over time.
The potential negative for sole traders is that you are personally responsible for all of the company’s liabilities. The downside of this is that, if your business happens to be sued, or has to file for bankruptcy, your personal assets (such as your own home) can be at risk of being seized.
A partnership is quite similar to a sole trader arrangement except for the fact that it involves ownership being split between two or more people, rather than being in one name. Businesses that are owned and run by multiple individuals are common in industries such as real estate and law.
Like a sole trader set up, partnerships are fairly easy to set up, and at reasonably low cost. The other benefit is that there can often be some tax advantages to reporting your individual share of the business profits and losses on your personal income tax return.
On the other hand, if you enter into what’s called a general partnership, your personal assets can be at risk if the company sinks or is faced with litigation (even if the issues are caused by other partners in the organization). However, you can choose a limited partnership instead. In this set up, while there’s still one general partner who bears unlimited personal liability, the limited partners are only liable for the amount of money that they have invested in the business.
A corporation is a much more complicated organization. It is actually an independent legal entity that is totally separate from its owners. Businesses that require liability protection, as well as the opportunity to grow significantly in the future, are often best set up as a corporation (for example manufacturers, hotels, restaurants, wholesalers, and the like.)
As you would imagine, one of the major benefits of being an owner in a corporation is that any business debt does not get transferred, and personal assets (apart from your interest in the company) do not get put at risk.
The downside to setting up a corporation is that it’s much more involved and more costly. It typically requires the assistance of lawyers and accountants in both set up and operation, in particular when it comes to yearly tax preparation.
Limited Liability Company
A limited liability company, or LLC, is a bit of a hybrid that mixes elements of both partnerships and corporation. Like the former, any profits or losses from the business pass through to the owners of an LLC, and they must report them on their personal tax returns. However, like a corporation, an LLC still provides protection from the personal liability that may arise from business debts.
When it comes to ease of set up and level of costs, a limited liability sits in the middle – more expensive and complicated than a sole trader or partnership, but easier to set up and operate than a corporation. The structure works well when business owners aren’t sure how much the organization is likely to grow.
The major benefit of an LLC corporate structure, apart from liability protection, is flexibility. With a limited liability company, owners have control over many aspects, such as who gets management rights; how the business is taxed; and how profits are distributed. A drawback to this structure that you should keep in mind though is that you may potentially have to pay self-employment taxes on your share of the ownership.
Dana Wilson is a freelance writer based in Edmonton, Alberta.