Yes, it’s a topic that’s a little on the dry side. But how you structure your business (in the legal sense) is one of the most important decisions you’ll ever make as a business owner. And it’s also a decision that you may choose to re-evaluate over time as you and you and your business go through changes like bringing on partners or investors, hiring employees or contractors, or choosing to exit the business either as a career change or for your retirement.
Princess Capybara didn’t initially give much thought to business structures…
If you’re a regular here at Zattatat, you know that Princess Capybara is a young serial entrepreneur. Her latest venture is a skin serum company that she purchased from its founder.
Anyway, Princess had acquired the business and made some “low hanging fruit” improvements to their processes, but now she was getting ready to divest herself of the skincare company and move on to her next project…
But she realized that before she attempted to sell or otherwise unload the business, she needed to think about…
Business Structures
There are several legal structures that a business can take in Princess Capybara’s country, the United States. Unlike most of the topics we cover here at Zattatat, business structures is a legal topic so it varies widely from country to country. (Usual disclaimer: this article is a manufacturing blog covering a topic that touches on legal issues. It is not intended to be used as a substitute for actual legal advice!)
Anyway, Princess Capybara asked her friend Process Cat for help deciding whether she should change the legal structure of her skin serum business before selling or otherwise getting out of it.
The first and easiest to understand business structures in the US are
Sole Proprietorships and Partnerships
A sole proprietorship is very simple indeed, and is the structure that the original owner of the skin serum business had used: the business doesn’t “really” exist separate from its owner in a legal sense, except that if it operates under a name other than the person’s own name, there is often a requirement to file as a matter of public record a DBA (Doing Business As) or FBN (Fictitious Business Name.) This is essentially just publishing in a local newspaper that, for example, “East Side Fish Shop” is owned and operated by a person named Lisa Moore in New Gloucestor Massachusetts.
And if Princess Capybara chooses to bring on a business partner?
The main advantages of a sole proprietorship or partnership are
- Simplicity, ease and cheapness of filing
- Pass-through taxation (meaning, the business doesn’t pay its own taxes – the income from the business simply counts as Princess Capybara and her partners’ personal income and is only taxed once.)
But the main disadvantage is that, if the business gets sued, people can come after her own personal assets such as her condo or her car or even her other businesses!
So Princess Capybara decides that it’s time to move on from a sole proprietorship or partnership. Process Cat recommends that they next look at the opposite end of the spectrum, which in the United States is…
C-Corporations
The very large, publicley-traded companies that you see on the financial news are usually C-corps. But smaller businesses can form C-corps too, and they don’t have to offer the opportunity to purchase stock to members of the general public unless they want to.
The main advantages of the C-Corp business structure are the limited liability for anyone involved in the company (unlike a Sole Proprietorship, if a C-Corp gets sued, usually only the assets in the corporation can be won in a settlement), and the option of raising money by offering stocks if that’s something you want to do.
The main disadvantages of C-Corps are the increased difficulty, cost, and time to form; the fact that corporations are taxed separately from their owners (so in the end you pay taxes twice!), and the increased regulatory hoops compared to other business structures.
Given the advantages and disadvantages, C-Corporation is the business structure that’s best suited to companies that have already grown large, or startups that plan to seek a lot of investment in hopes of growing large.
Princess Capybara decides that this isn’t really the best fit for her skincare serum business either, so Process Cat encourages her to look into…
LLC’s and S-Corps
Yes, luckily for Princess Capybara and many of us small business owners, there is a business structure that fits well for businesses to large/with too much liability to be Sole Proprietorships, yet too small for being a C-corporation to really make sense.
The older of these business structures is the S-Corp. S-Corp’s may be owned by a single, self-employed individual, or a group of up to 100 shareholders. They have some of the benefits of Sole Proprietorships (pass-through taxation being the biggest one), and some of the benefits of C-Corporations (ability to offer stocks and limited liability being the biggest ones.) But, they do share one major disadvantage with C-Corporations, and that’s heavy regulation. Which is why most small-to-medium-sized businesses now choose to be…
Limited Liability Corporations (LLC’s.)
LLC’s are subject to far fewer regulations than S-Corps, while still retaining the advantages of pass-through taxation and limited personal liability. Their only real disadvantage as compared to an S-Corp is that they can’t sell stocks. Therefore, LLC is the business structure most often chosen by law or medical practices or other businesses of similar sizes, and also the one that Princess Capybara decides makes the most sense for her skin serum business at this time.
Weekly Challenge:
Think about whether or not you’ve chosen the best of these 3 business structures for your business – and if you feel like none of these are quite right, come back next time for a discussion of other structures like Nonprofits, Not-for-profits, ESOP’s, Co-ops, Benefit Corporations and Certified B-Corps!
