How to Choose a Legal Structure for Your Small Business

Business.com / Strategy / Last Modified: February 22, 2017

When you look into choosing a legal structure for your business, ask yourself these three questions before choosing the one that meets...

Business structure formation is not exactly a topic that business owners clamor to read about, but it is important for entrepreneurs to understand as much about it as possible. Sole-proprietorship is typically the default business structure entrepreneurs wind up working with and while it's easy to form, it doesn't provide you with much fiscal or legal protection. If your business doesn't take off quite like you expected, or if the business is sued, debtors could seize your personal assets to pay for the business's liabilities. I know firsthand how it feels to stare into the unknown and wonder if the gamble to start up your own company is worth taking. Though turning your business into its own, separate legal entity may seem daunting, it does lower the stakes, especially when you research the structures beforehand. So, when you look into choosing a legal structure for your business, ask yourself these three questions before choosing the one that meets your needs.

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1.       Why did I start this company?

I've asked countless entrepreneurs to answer this question, and rarely do they respond 'to make money.' Running a business is not a quick path to riches. Successful businesses require a ton of time, dedication, and effort. Undoubtedly, there is another reason behind your decision to strike out on your own as opposed to working within a corporation. Were you working out of your garage and decided it was time for a more official storefront? Was there a gap in the market that you could fill? Did you feel that you could make a real difference running a business? Nailing down exactly why you started your company will help you to find the right business entity. A limited liability company (LLC) is a great fit for a small business owner looking to separate the business's debts from their personal assets, without getting muddled down in tax and administrative obligations. Corporations, on the other hand, will have an easier time finding investors, so the inevitable next question is...

2.       Do I want to attract outside investment?

It is possible to invest in an LLC, but many investors and firms are apprehensive to do so because the process is less understood, and they may prefer investing in a company that will eventually have an initial public offering. You can sell stakes in an LLC, but any investor that buys a stake, even a small one, will usually have full management rights. So unlike a corporation, which can have stockholders that aren't involved in the day-to-day operations of a company, any investor in an LLC could be meddlesome. Corporations are thus a better fit for entrepreneurs looking for outside investors. However this can open you up to legal action from shareholders, so the next question is...

Related: 10 Things You Must Do Before Starting a Business

3.       Will I need any extra protection?

Forming a corporation means you have a fiduciary duty to your stockholders. Every business decision must be made with a mind for maximizing profit. If you founded your company with the intent to make an impact along with a profit, your social mission might have to be abandoned. Luckily, there is a new type of corporate formation called a Benefit Corporation that is currently recognized by 19 states and the District of Columbia. Benefit Corporations provide the same protection that standard ones do, but directors and officers are also protected from any sort of action when considering the business's mission when making decisions. However, this structure is still fairly new, so there isn't a lot of precedent to fall back on, which might make investors nervous. At the same time, there are also investors looking specifically to help businesses that are trying to make a positive impact.

Related: Find more resources for incorporation services.

You can always change business's structure later on, but choosing and sticking with one particular structure will make life for your business easier as you continue to learn more about the entity in the coming years. If you're not sure what entity best fits your business, take the time to read up about the different structures, and choose the one that fits your needs. That way you'll have the protection you need, and be able to handle the administrative obligations that your particular business structure must abide by.

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