On the list of life-altering decisions you’ll make when trying to start a business, picking the legal structure that best complements your venture is high – like, at the top.
You have at least four big ones to consider: S corporation; limited-liability company, or LLC; sole proprietorship; and partnership. (There are more, but these are the ones you’ll read about here.)
Each is different and carries its own degree of risk and reward for the entrepreneur.
ShopTalk spoke with Charlotte-area attorneys and business owners to give you a quick primer on each one. First, here’s a disclaimer:
“There’s no one size fits all for this,” says Joanie Winters, an employment attorney who owns Winters Law Firm in Chester and York counties in South Carolina. “The individual has to do some analysis … primarily because it depends on the individual’s tax situation.”
After starting her Charlotte-based design and marketing studio, Moonlight Creative, in 1996, Dawn Newsome chose to register her business as an S corp, a sub-chapter of a corporation. It made “complete sense,” she said.
Benefits: S corps enjoy tax benefits: profits and losses are “passed through” to the owner, who can report them on his/her tax return.
And a business owner’s individual assets – such as a home, car or bank account – are protected from legal liability if a customer sues the business.
It’s also affordable. Newsome said she pays about $60 in annual filing fees –$25 to file an annual report and an additional $35 fee – to the secretary of state. Costs for LLC filings can exceed $200.
Drawbacks: Owners pay quarterly tax returns. They also have to hold and document yearly shareholder meetings, even if they’re the only company shareholder. Newsome signs a consent form once a year that allows her to fulfill the meeting requirements without holding an actual meeting. S Corps in North Carolina, but not in South Carolina, are required to have a board of directors.
Limited-liability company (LLC)
Travis Jackson’s decision to register his marketing business, HBCU Pride Nation, as an LLC came at the suggestion of a mentor in 2011. Today, he’s grateful.
“If something goes wrong and somebody sues … they wouldn’t be able to sue me for my own personal assets,” he said.
While a benefit like this is similar to what an S Corp offers, one difference is that an LLC allows business owners to choose how they want to be taxed – either as a sole proprietorship, partnership or corporation. Depending on what they pick, they might be free from filing tax returns. LLCs are made up of an unlimited number of members who have input in how the business is managed, whereas an S Corp is limited to 100 shareholders who own stock in the company and might have no say in its operations.
Benefits: It only takes filing an articles of organization with the secretary of state to get started. Owners are not accountable for the business’ debts or legal troubles, and profits and losses can pass through to the owner’s tax return.
Drawbacks: LLC members must create operating agreements showing which partner owns what percentage of shares in the company, Winters said. An LLC member can’t sell his/her interest in the company unless all the other members agree. And forming LLCs can be complicated. If business owners aren’t careful, their net income becomes subject to self-employment tax.
This is the easiest business structure to form – it involves just one person. Little paperwork or licensing is required, unless the owner is in a specific trade, like a plumber. Owners pay self-employment tax.
“I just start washing people’s cars, and charging them money, and that’s it,” explained attorney Fred Parker with Gardner Skelton PLLC in Charlotte.
Added Keith Hance of Hance & Hance P.A. in Gastonia: “There’s nothing to do but start working.”
Benefits: Simplicity and autonomy, experts say.
“It’s simple to operate, it’s simple to manage, it’s simple to deal with your taxes,” Parker said.
“All the profits are yours,” Winters said. “Control, management and decisions are yours.”
Drawbacks: “There’s no protection for you personally,” Winters said.
“You’re the only one working in the business. You get sick, the money stops.”
Adds Hance: “If Joe Smith is doing business as ‘Joe’s Barbershop’ and he has an errand boy who runs over somebody, there is no Joe’s Barbershop that exists as a separate entity. The only person to sue is Joe Smith. If somebody slips and falls at the barbershop, the only person responsible is Joe Smith. There’s nobody else to blame if something goes wrong, except the sole proprietor.”
This is when two or more people or businesses pursue a joint venture together with plans to make a profit, Parker said. It can be completely informal and doesn’t require a contract (attorneys recommend a contract).
Winters compared it to a marriage: “You have the romance stage where your partner can do no wrong. A little into the marriage, your partner is leaving the socks on the floor, leaves the toilet seat up, but you work through it, get back to the romance stage, if you can. But what if you can’t? Till death do us part doesn’t work in the partnership. Usually, a partnership gets dangerous when money starts coming in.”
Benefits: With a contract, partners can outline each owner’s responsibilities and decide who gets what share of the income and tax burden, Hance said.
Drawbacks: Every partner is liable for any wrongdoing on the part of the business, and written agreements won’t guard one partner from the harmful actions of another, Parker said. In the event of a lawsuit, an innocent partner can suffer loss if the guilty one has no assets to relinquish.
Said Parker: “You’re … putting yourself at risk based on what your partner does.”