Before you register a business, you decide what kind of business it is in the eyes of the law. That choice is your business structure. It affects how much of your own property is at risk if something goes wrong, how you pay taxes, and how easily you can borrow money.
The SBA lists sole proprietorships, partnerships, and limited liability companies (LLCs) among the common options, along with corporations. Here is what the first three mean for a founder who is just starting out.
Sole proprietorship: the default
If you start selling something and do not register as any other kind of business, you are automatically a sole proprietor, according to the SBA. It is easy to set up and gives you full control. The tradeoff is that the business is not separate from you. Your business debts and legal obligations can become your personal responsibility, and the SBA notes that banks tend to be cautious about lending to sole proprietorships.
The SBA describes it as a reasonable fit for low-risk businesses and for owners who want to test an idea before forming something more formal. The SBA’s business name guide adds that most states require you to register a DBA if you operate under a name other than your own.
Partnership: two or more owners
A partnership is the simplest structure when two or more people own a business together. Simple does not mean casual. Put in writing who contributes what, who makes which decisions, how profits are split, and what happens if one person wants out. That conversation is far easier before the business is making money.
Partners in a general partnership can be personally responsible for the business’s debts, unless the partnership is set up as a limited partnership. Ask an attorney or counselor which version fits your plans.
LLC: separating you from the business
An LLC combines features of a corporation and a partnership, according to the SBA. In most instances it protects your personal assets, such as your vehicle, home, and savings, if the LLC faces a lawsuit or bankruptcy. Profits and losses can pass through to your personal tax return, so the LLC itself does not pay corporate income tax. LLC members are still considered self-employed, so they pay self-employment tax for Social Security and Medicare.
The SBA says an LLC can be a good choice for medium-risk or higher-risk businesses and for owners with significant personal assets to protect. Forming one means filing with your state, and the cost and rules depend on where you live. Some states also limit how long an LLC can exist or require it to reorganize when members change, so ask about that if you plan to bring in partners later.
What about corporations?
Corporations and S corporations bring more paperwork and more rules, and they tend to make more sense once a business has grown or has several owners or investors. If you think you might need one, talk to an accountant first, because the tax effects depend on your situation.
Questions to ask before you choose
- What could go wrong? Think about injuries, damaged property, unpaid debts, and unhappy customers. Higher-risk work points toward more protection.
- What do you own that you would hate to lose? A home, land, vehicles, and savings are the personal assets that limited liability is designed to protect.
- Are you starting alone? Co-founders need a written agreement no matter which structure they choose.
- Will you need to borrow soon? Lenders look closely at how a business is set up. Our guide on funding options for new founders covers what to know before you ask.
- What will it cost to set up and maintain? Ask your state and county which fees and annual filings apply.
Your first choice is not permanent
The SBA points out that you can start as a sole proprietor and convert to an LLC if your business grows and your risk of personal liability increases. That makes it reasonable to start simple while you test your idea, as long as you understand the risk you are carrying in the meantime.
State rules and tax treatment differ, and this article is general information rather than legal or tax advice. An attorney, an accountant, or a business counselor can check the details for your state. Our guide to free business help for new founders explains where to find one.
Your next step
Write down what you plan to sell, who will own the business, and what you own that needs protection. Take that page to a counselor or accountant, then follow up with our guides on choosing and protecting your business name and getting an EIN.