Choosing the right business structure is more important than most first-time business owners know. Whether you’re starting a company as a vehicle for further investment or an entrepreneurial effort unto itself, the same considerations apply, although the direction your decision runs might change dramatically. That’s because the various choices of the corporate structure open to businesses when they start represents a range of options tailored to meet a variety of different needs. Jumping in without understanding what each business structure is designed to do means potentially choosing an expensive organizational structure for your particular business type, instead of the more efficient option that delivers everything you need.
Many small business owners assume the LLC is the best choice because of the way it limits liability and the choice of methods of taxation. While there are a lot of good reasons to choose the LLC for specific business types, the assumption it is a universal good is actually harmful to entrepreneurs who might be better served by another option. One very obvious example of a case where an LLC can be a costly investment is when the partners do not receive any money in dividends but the company owes more tax than it has cash on hand. In those cases, the tax structure of the LLC by default costs them money because they are individually responsible for paying income tax on its income. By contrast, a C corp simplifies investor taxation by requiring a capital gains event to trigger partner tax obligations as part of its corporate structure. Investors tend to prefer it.
For those who own the business as a sole proprietor, often an LLC can protect them from some liability while still providing them the same tax structure as a sole proprietorship that is not one, and that tends to be when it is most advisable. Some limited partnerships also opt for it instead of an S corp or C corp for their own reasons, but typically these choices are made by companies with active partners who participate in the daily operation of the business, and they are incredibly context-dependent.
Another option with a lot of advantages is the previously mentioned S corp. Where a C corporation protects investors from paying taxes unless there is a capital gains event, an S corporation has no tax obligations on its own, all the tax obligations fall to the partners, and they are pro-rated according to the stock holdings of each. This can be a great advantage to businesses being incubated by a core group of capital investors looking to keep its operations as simple as possible, making it a preferred method for many companies whose primary reason for existing is an investment in other companies.