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Types of Legal Structures to Consider

Finding the right legal structure is a core component of any successful business launch. Today learn about the options many entrepreneurs consider.

A man opening a coffee shop for business.

Starting a business comes with myriad of key decisions and responsibilities. One of the most important of these early decisions involves your legal structure. What you do here may have profound tax, legal and financial implications, so it's important to make the right choice.

With that in mind, here's an overview of the various structures, and information about where and when each option makes the most sense.

Sole Proprietor

If you're looking for something simple and streamlined, you may wish to pursue a sole proprietorship. This structure is the most common in the U.S. and has exploded in popularity over the last three decades.

You don't have to take any official action to form a sole proprietorship. Simply being self-employed and earning money is enough to give you sole proprietor status. That doesn't mean you are exempt from any relevant permits or licenses, however. Sole proprietors are also potentially legally liable for debts and losses.

Additionally, sole proprietors are responsible for keeping track of their own taxes, including self-employment taxes and quarterly estimated taxes, thoughout the year.

Corporations

Even the most novice businessperson is familiar with the concept of a corporation.  A corporation is shareholder owned and legally independent business venture. This means the corporation - not the owners - are typically liable for damages or debts.

One popular corporate structure is the "C" corporation. The corporation structure works best for larger and more complex organizations since income is taxed twice - once for the corporation and again for employees / shareholders when paid out as salary. Another type of corporation is the "S" corporation. In this case, earnings pass through to shareholders at the end of the year.

Typically, to form a corporation, you need to file articles of incorporation with your state government or, in some cases, another state's government (Delaware is often used as a home state for many corporations).

Unless you're planning on starting with multiple employees and a relatively large budget, the corporation structure likely isn't for you since many of the benefits are available by forming a simpler Limited Liability Corporation (see below).

Partnerships

A partnership is simply a business venture with multiple owners. Partnerships can be equal (called "General Partnerships") or unequal ("Limited Partnerships") regarding ownership share and liability.

Starting a partnership requires a few steps: registering your business, establishing a name, and securing licenses and permits. Partnerships are a great way to pool risk, tap into the skill sets or experience of multiple people and share startup costs. Partners do sometimes disagree, however. It's also important to note that partners can be personally liable for debt.

Limited Liability Corporations

A Limited Liability Corporation (often just shortened to "LLC") is similar to a C or S corporation in that it offers legal protection. In other ways, however, it resembles a partnership. An LLC offers tax benefits and flexibility much like a partnership, as all profits (or losses) are assigned to the individual LLC members, rather than the corporation.

Much like corporations, LLCs are created through a process that includes drafting articles of incorporation and possibly drafting an operational agreement between partners.

The Takeaway

Finding the right legal structure is a core component of any successful business launch. By studying the options listed above, you can make the most informed choice possible - but, above all, consult with a legal professional before determining your business structure. There are other considerations that are beyond the scope of this article.