The legal structure of your company is a key decision. Here are
the most common options.
Sole Proprietorship:
This is the simplest structure, and usually involves just one
individual who owns and operates the enterprise. Tax-wise, this
structure is appealing because business expenses and income are
included on your personal income tax return, and business losses
you suffer may offset other income.
Disadvantages: You're personally responsible for your
company's liabilities, so your assets could be seized to
satisfy a business debt or legal claim. Banks and other financing
sources may be reluctant to make business loans to sole
proprietorships.
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Partnership: In a
general partnership, the partners manage the company and are
responsible for its debts. A limited partnership has both general
and limited partners. The general partners own and operate the
business and assume liability. The limited partners serve as
investors only; they have no control over the company and
aren't subject to the same liabilities as general partners.
This is usually not the best choice for a new business.
A partnership does not pay tax on its income but "passes
through" profits or losses to the individual partners.
Disadvantages: General partners are personally liable for
the partnership's obligations and debt. Each general partner
can act on behalf of the partnership, making decisions that are
binding on all the partners (if the partnership agreement permits).
Partnerships also cost more to set up than sole
proprietorships.
Corporation:
Incorporation protects your personal assets from liability and
makes it easier to raise money.
Disadvantages: Because a corporation follows more complex
rules and regulations than a partnership or a sole proprietorship,
it requires more accounting, tax and legal services. Owners of the
corporation also pay a double tax: Corporations are subject to
corporate income tax at both federal and state levels, and earnings
distributed to shareholders as dividends are taxed at individual
tax rates on their personal tax returns. (To soften the blow, pay
the money out as salary instead of dividends.)
To incorporate, contact the secretary of state or the state
office responsible for registering corporations in your state.
Using a lawyer costs from $500 to $1,000, or you can file for
incorporation on your own using books and software.
S Corporation: The S
corporation has the liability protection of a regular (or C)
corporation. Income and losses are passed through to shareholders
and included on their individual tax returns, so there's just
one level of federal tax.
Disadvantages: S corporations are subject to many of the
same requirements as corporations, meaning greater legal and tax
costs. Restrictions on S corporation stock can hinder efforts to
raise capital.
Limited Liability Company
(LLC): LLCs provide the liability protection of
corporations, without the double taxation-earnings and losses pass
through to the owners and are included on their personal tax
returns. Unlike an S corporation, the LLC has no limitation on the
number of shareholders. Any member of the LLC can have a full
participatory role in the business's operation. To set up an
LLC, file articles of organization with the secretary of state in
the state where you intend to do business.
Buying Business Insurance
Failing to buy insurance for your startup can be a costly
mistake. Most property and casualty companies offer special
small-business insurance policies. A standard package combines
liability; fire, wind and vehicle damage; burglary, and other
common coverages. Typical qualifiers are that your business occupy
less than 15,000 square feet, and the combined value of your
building, operation and inventory be less than $3 million.
Basic package policies usually cover buildings, machinery,
equipment and furnishings. That protects your company's
computers, phones, desks, inventory and the like against loss due
to robbery and employee theft, in addition to risks such as fire. A
good policy pays full replacement costs. A package policy also
includes business interruption coverage, which can provide enough
to meet your overhead and other expenses if a disaster puts your
business out of commission. Many policies also cover personal
liability.
If you have employees, you'll also need workers'
compensation insurance. Because insurance agents aren't always
up-to-date on workers' comp laws, check with your state's
department of insurance or insurance commissioner's office to
see what you need.
Look for an insurance agent familiar with small business; ask
your peers for recommendations. Some trade associations provide
referrals and may even offer group coverage with attractive rates.
Make sure the company your agent selects or represents is highly
rated. Worldwide insurance-rating and information agency A.M. Best provides
ratings of the financial strength of insurance companies.
Mother, May I?
Forgetting to obtain licenses and permits could come
back to haunt you. Here's what you may need:
- Fictitious Name (dba): If you have a sole proprietorship
or partnership and want to operate under a name other than your own
(for instance, Carol Axelrod doing business as "Carol's
Collectibles"), you can choose a fictitious business name or
dba ("doing business as"). The county, city or state may
require you to register your fictitious name. Procedures vary;
contact your county clerk's office for information.
- Business License: Contact your city's business
license department to find out about getting a business license,
which grants you the right to operate in that city.
- Health Department Permit: If you plan to sell food, you
will need a county health department permit.
- Fire Department Permit: If your business uses flammable
materials or will be open to the public, you may need a fire
department permit.
- Air and Water Pollution Control Permit: Check with your
state environmental protection agency to see if any state or city
regulations apply to your business.
- County Permits: County governments often require the
same types of permits and licenses as cities. If your business is
outside of any city or town's jurisdiction, these permits apply
to you.
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