Running a Small Business: How to Choose the Right Legal Structure For Your Small Business

22 Dec
Choosing the Right Legal Structure: Q&A with Elizabeth Bradford from Start Small Think Big

 

Small business legal structures— like sole proprietorships, limited liability companies (LLCs), and S or C corporations— have different tax and liability obligations. The U.S. Small Business Administration (SBA) website has an overview of small business legal structures (as the Internal Revenue Service, or IRS, defines them), along with pros and cons of each type of entity.

Before you choose, Excelsior Growth Fund (EGF) recommends getting tax and legal advice on how to set up a small business from your accountant and attorney.

For additional insight, EGF also interviewed Elizabeth Bradford, Legal Program Director at Start Small Think Big. Start Small’s mission is to help low- to moderate-income individuals build and sustain thriving businesses to increase personal financial security and stimulate economic activity in underserved communities in New York City. Start Small Think Big matches entrepreneurs with top tier attorneys in the NYC area for pro bono services. Here, she shares valuable advice.

Why is it important to select the right legal structure for your business?  

There are many reasons why it is important to select the right legal structure for your small business. This decision should be given careful consideration, as it will affect how you own and operate your business, as well as how you are taxed.

Personal liability is also a major reason to select the right structure. Not all options protect business owners from personal liability for business decisions or actions. For example, the sole proprietorship structure does not protect your personal assets if someone were to sue your business. Other structures, such as a limited liability company (LLC) and corporations, protect your personal income and assets from many types of business liabilities.

Key Takeaway: Select the legal structure that meets your small business’s financial, legal, liability, and tax needs.   

What factors should a small-business owner consider during the decision-making process?

There are several factors to consider during the decision-making process including tax treatment, record-keeping and corporate governance requirements, flexibility of ownership structure, and the cost of forming and maintaining [a] legal structure.

Tax treatment varies between the different structures. For example, in the sole proprietorship, LLC and S Corporation structures, your business profits are passed through to you and taxed solely as part of your personal income. A C Corporation, on the other hand, files taxes separately from its owners and some of the income is taxed twice – first, when the business makes a profit, and second, when dividends are paid to shareholders.

Another factor to consider is operational requirements. The complexity of corporate governance is a great example. The Corporation structure (C or S) requires director and shareholder meetings, adoption and updates to by-laws, and stock transfers, to name a few.  In an LLC, you can create a more flexible ownership and management structure.

Finally, consider the initial cost to form the entity and any ongoing costs to maintain it. Corporations tend to have higher costs for tax preparation and payroll processing. In New York State, however, limited liability companies (LLCs) are required to publish a statement announcing their formation in the local publications. Depending on what part of the state you live in, this publishing requirement could be costly.

Key Takeaway: Consider all the tax and legal implications of each structure.

When should a small business owner start the process of forming an entity?

When your business is far enough along to know it’s viable, you should start the process of forming a business entity. For many business owners, this comes at the time when they commit to their business full time. It is also a good idea to form an entity sooner rather than later for personal liability reasons. Finally, forming a business entity also gives your business more credibility in the eyes of potential clients, suppliers and/or investors.

Key Takeaway: When timing selection of your business’s legal structure, consider whether you’re committed to moving forward, how much business risk you’re incurring and whether you’re ready to look for major clients or investors, or both.

Who can help small business owners through this process?

It is recommended to meet in person with a legal and tax professional. Simply seeking guidance online is not enough. The process ofselecting a business entity requires fairly detailed tax advice. You will need someone to look at the various business structures through the lens of your business – taking into consideration the details of your current and future business needs.

At Start Small Think Big, eligible clients receive free advice on entity selection and assistance with formation from a legal professional (filing fee still applies). Anyone interested can find our application online and, if eligible, will be asked to come in for [an] intake interview. From there, you are matched with a volunteer attorney from a New York City law firm to give you guidance on entity formation and assist you with any other legal needs you may have -- such as contracts, employment and intellectual property. Start Small may also be able to assist you with bookkeeping and other small business financial needs.   

Key Takeaway: Get the advice of tax and legal professionals when deciding on which legal structure is best for your business. The investment you make on the front end of this decision will be worth it in the long run.

About Excelsior Growth Fund

Excelsior Growth Fund (EGF) helps businesses in New Jersey, New York and Pennsylvania grow by providing streamlined access to business loans and advisory services. EGF’s signature product, the EGF SmartLoan™, provides up to $100,000 in fast, transparent, and affordable financing through a secure online platform. Larger loans up to $500,000 are also available. EGF is a nonprofit organization and is certified by U.S. Department of Treasury as a Community Development Financial Institution (CDFI). Learn more atwww.excelsiorgrowthfund.org