What Business Entity is Best For Your Small Business
Now that you have decided to register your small business, what business entity type is best? The most common business entity options to choose from are usually sole proprietorships, partnerships, and private limited liability companies.
Recall from my previous article, I took you through the advantages of registering your business. Among the key pros of registering your business is that it helps with branding and reputation, banking, managing taxes, and even approaching investors.
In this article, I will help you decide what business entity is the best choice for your small business. We will talk about sole proprietorships, partnerships, and private limited companies.
So, let’s get right into it!
Sole Proprietorship vs Partnership and Private Limited Company: Which Business Entity Is Best For Your Small Business?
When planning to register your small business, there are several factors you need to consider. You have to consider the size, the commercial activity you plan to engage in, the owners, the number of employees, and the local laws guiding that particular trade or service.
Each option has pros and cons. It’s important to consider them before settling for any business type. Let’s look at the 3 business entity types individually and help you make a more informed decision.
An individual owns sole proprietorships. This type of entity is best for anyone who wants to keep their business small with no expansions. But, if you are hoping to scale your operations in the future, you should register your business as a private limited company.
A sole proprietorship is assumed to be an extension of the owner. Therefore, it lacks limited liability. Any liabilities incurred by the business extend to the owner. If your business has any debts, you are still liable as an individual to pay them.
On taxes, this type of business has a less hectic tax filing process. That’s because the business taxes pass through your individual returns. That means you file them as one, compared to a private limited company, where you have to file for yourself and the company separately.
You may have big plans and hope to expand later on. Registering as a sole proprietorship would limit your goals. Sometimes, banks and other funders may also be unwilling to lend to sole proprietors. The fear is that there is no distinction between the owner and the business.
Sole proprietorships are best suited for owners who enjoy working alone and have no plans for expansion and succession. You should consider this option when you plan to keep the business small, have no plans to split ownership, and hope to have a few employees, if any at all.
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Are you and your friends or a relative coming together to start a business? Partnering to create a business with another individual/s is what leads to partnerships.
But is this the best option for your small business?
Partnerships allow individuals to enjoy synergy and economies of scale. You can all come together to contribute the capital needed for the company. In addition, you can all share responsibilities for running the company as you wish.
However, be keen on the type of liability the partnership gives you as an individual. With a general partnership, every partner is liable for the business’s debts. It could extend to your personal belongings if what the company owns as assets is not enough.
A limited partnership (LP) gives at least one partner general partnership. If you are the general partner, you will be liable for any business debts. However, your limited partner/s are more investors. Therefore, they do not manage the business and will not be liable for any debts.
On the other hand, limited liability partnerships (LLP) are more like general partnerships. They are pretty common in certain professions, like accountants, lawyers, and doctors. Every partner is involved in the management of the business. The only difference is with the liability, where a partner’s liability to the business’s debts is limited to their own errors and omissions. It simply means that you are not responsible for your partner’s mistakes in the business. However, you will all bear any legal liabilities that the business might have.
Some states have a fourth type of partnership, the limited liability limited partnership (LLLP). While it is more like an LP, where there is at least one general partner, an LLLP offers liability limits for the general partner, too. With this, every partner will have protection against the liabilities of the business.
Like sole proprietorships, taxes from a partnership pass through your individual tax records. You report the income from the partnership and are allowed to deduct expenses from the business.
Private Limited Liability Company
Private limited liability companies are separate legal entities. The law sees them as individuals.
They can sue and can get sued. Should you decide to set up your business as a company, this arrangement prevents you from being personally accountable for mistakes or problems caused by your company or its employees. If anyone has a legal case against your company, your company gets sued instead of you.
Companies can own assets and incur liabilities like any other individual. Entrepreneurs sometimes set up startups with the goal of selling them at a future date. Setting up the startup as a private limited liability company helps keep company assets and liabilities separate from the owner, making it easier to sell.
Unfortunately, sometimes firms face hard times and go bankrupt. When these problems happen, a court-appointed trustee sells off the company’s assets to pay the creditors. Your assets are safe from liquidation when you register a business as a company because the company owns the liability, not you.
Startups sometimes pay employees with equity. If you plan to pay employees in equity or take on more investors, registering as a private liability company will allow you to allot shares to investors or employees.
When companies take loans, they are allowed to deduct interest repayment as allowable expenses. This opportunity makes it possible for you to use debt to grow your business. In addition, companies can get a lot of tax benefits from the government. Ensure you work with a CPA for tax advice and management to ensure you do not pay more than the necessary tax.
Choosing the right business entity for your small business can be overwhelming. However, it actually doesn’t have to be a hassle. Sole proprietorships allow you to operate as a sole owner but without limited liability. That means you will be liable for any debts your business incurs.
Partnerships, on the other hand, come in several types. It’s important to understand how each partnership works. With a general partnership, every partner bears the losses and profits of the business with other individuals. Like a sole proprietorship, general partnerships don’t offer limited liability, and losses or profits pass through the partner’s individual taxes. A limited partnership (LP) will give at least one partner a general partnership, and the other partners have limited liability. Finally, for professionals like lawyers and accountants, limited liability partnerships (LLP) are the ideal business entity.
Then, we have limited companies that offer limited liability. Many entrepreneurs who are owners of successful businesses today have previously set up companies that failed. But they tried again because they did not lose their personal assets. The legal framework guiding private limited liability companies is very beneficial to small businesses. If you hope to grow a successful business, this is the best option for you.
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