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3 Tips For Choosing The Right Entity For Your Startup

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The term “entity” in business refers to an organization run by either an individual or a group of people. Every business entity operates under one of four different business structures.

The structure dictates several things about the establishment, such as how it operates and how it’s taxed. Certain business entities enjoy several benefits according to their structure, like occasional tax reductions and accessible funding. These merits also come with numerous challenges, like limited flexibility and control. Therefore, it’s advisable to gain knowledge of the different business entities first, though you can also seek the help of a business filing specialist to do it for you.

If you wish to register the startup yourself, this article should help, as it tackles three tips on choosing the right entity for your startup. Let’s start with the most essential tip.

  1. Understand Your Different Options

Before anything else, you must know what your options are and what each option entails.

There are generally five different types of business entities. Each entity is best described by its respective benefits and challenges or the lack thereof.

Here’s a brief overview of what each entity entails:

  • Sole Proprietorships: As the name suggests, a sole proprietorship is a business entity run by a single or “sole” individual.
  • Partnerships: Partnerships are run by at least two individuals who are the owners of the startup.
  • Corporation: A corporation is an entity separate from the people who run it. It has the same rights as its owners, such as the right to hire employees, take loans, and pay taxes.
  • Limited Liability Company: A limited liability company (LLC) is a hybrid entity that incorporates the characteristics of corporations with that of partnerships.

Note: The limited liability company entity is exclusive in the United States.

With this, you now know your available options. The next step would be to assess your startup’s needs if you wish to make the right choice.

  1. Assess Your Startup’s Needs

Every startup has specific needs, some of which you can easily satisfy by choosing the right business structure. Therefore, you must consider the startup’s needs when choosing the entity.

Examples of these needs may include the following:

  • The need for funding
  • The need for control over the company
  • The need to protect one’s assets
  • The need to avoid liabilities
  • The need to save money on taxes
  • The need to save money on operating costs
  • The need to offer a share of ownership to key employees

The right entity will differ according to these needs, among many things. With this in mind, you must then determine the advantages and disadvantages of an entity according to your needs.

  1. Weigh The Pros And Cons Of Each Entity According To Your Needs

Choosing the right entity for your startup may not be feasible now as you have yet to understand what each entity offers. With that being said, here’s a look at the pros and cons of each entity:

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Startup company desk reviewing the different types of business entities.

Sole Proprietorships

Pros:

  • Only one person runs a sole proprietorship, meaning that one person will have full control over the startup.
  • The sole owner would also receive the entirety of the profits generated by the startup.
  • You can reduce your owed taxes by including your business losses on the tax return.
  • Registering a sole proprietorship is a lot easier as opposed to other business entities.
  • Filing taxes is easy. The sole owner must simply report the business income as well as losses on their personal income tax return.
  • You can incorporate a sole proprietorship, later on turning it into a corporation.

Cons:

  • The sole owner will have to carry the burden of all responsibilities associated with the startup. These may include bank debt, mortgage debt, and wages owed.
  • A sole proprietorship doesn’t enjoy the benefits that other entities do, like tax reductions and accessible funding.
  • Hiring top-notch employees will be a challenge.

Partnerships

Pros:

  • The partners will share the responsibilities or liabilities associated with the startup. This means starting the business is easier since each partner can contribute to the funding.
  • Filing taxes is fairly straightforward as each partner must pay taxes according to their share of profits. The partnership itself isn’t liable for taxes.
  • It’s much easier to take out loans than when you’re running a sole proprietorship.
  • Like sole proprietorships, it’s possible to switch from a partnership to a corporation.

Cons:

  • No one has full control over the startup, as each partner owns a part of it. Hence, partners may take reckless actions that may endanger the entirety of the partnership.
  • Conflicts of interest can take place within the organization.
  • You must deal with a ton of paperwork whenever a partner joins or leaves.
  • Each partner takes a portion of the startup’s income as their own, reducing your share.

Corporation

Pros:

  • Not a single person is held responsible for liabilities like debt or taxes. The corporation is considered a legal person, and therefore, it’s the entity liable for these responsibilities.
  • You can easily retire by selling the stocks or shares you own to other shareholders.
  • Corporations are more likely to get approved for loans than individuals (sole proprietors).
  • You can easily attract high-caliber employees.
  • Shareholders can decide to expand the company across the entire country.

Cons:

  • The process of becoming a corporation is rather challenging compared to other entities.
  • Certain types of corporations may be subject to double taxation where the startup, as well as the shareholders, are taxed, though this is a rather special case.
  • Anyone can become an owner of the corporation as long as they buy enough shares of the company. In short, the hierarchy may vary according to their monetary contributions.
  • There are limited privacy as financial affairs concerning the startup must be made public.

Limited Liability Company

Pros:

  • The owners are free from the company’s liabilities, such as the repayment of the debt, much like corporations. An exception to this would be the tax, as all owners must pay taxes based on their share of profits from the LLC, similar to how partnerships are taxed.
  • Members of the LLC can withhold their tax by refusing to accept their share of profits in the meantime. This is because, in an LLC, income is only earned when received.
  • All members of the LLC can deduct their personal income tax using business losses.
  • Double taxation is unlikely in LLCs, at least when compared to corporations.
  • There’s no limit to how many stockholders or shareholders the LLC can have.
  • An LLC can take out loans more easily than partnerships and sole proprietorships.

Cons:

  • The combined taxes paid by the members of the LLC are usually higher than what corporations pay. This is because LLC members are subject to personal taxes like self-employment, social security, and healthcare taxes.
  • LLCs usually cost more money to establish, though not as much as corporations.
  • Investors are less likely to invest in LLCs as opposed to corporations.

Now that you know the pros and cons of each entity, it should be easier to decide which option is best for your purposes. For example, if your business requires a lot of funds, choosing the entity LLC or corporation is ideal as they make taking out loans easier. Similarly, if you have everything you need, it’s best if you choose sole proprietorship so you can enjoy the profits all for yourself.

Final Words

By now, you should’ve already decided which entity you’re choosing. It may have been confusing and overwhelming, but at least now you won’t regret making your decision. After all, with the tips mentioned above, you can safely say that you’ve made a well-thought-out decision. Now, you just need to make your startup succeed by applying your business skills to the fullest.

 

We are a team of writers passionate about innovation and entrepreneur lifestyle. We are devoted to providing you the best insight into innovation trends and startups.

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