Choosing the Right Business Structure: A Guide for New Entrepreneurs

Forming a new business isn’t easy, no matter how prepared you are. One big decision you’ll need to make as an entrepreneur is which legal structure will define your business’s liability, tax implications, maintenance requirements, investment needs, and more. So, what is the legal structure of a business, and which one is right for you?

Below, an experienced business law attorney in Denver from Thomas N. Scheffel & Associates, P.C., discusses everything you need to know about the different types of business entities. For personalized guidance, reach out to our team.

What Is a Business Structure?

A business structure is the legal framework defining business profits, taxation, and ownership liability and should be at the top of your business checklist. Your business legal structure organizes how your company operates in the eyes of the law, impacting everything from day-to-day operations to court filings and ownership responsibilities.

Why the Legal Structure You Choose Matters

The entity you choose for your business has short and long-term implications affecting your:

  • Personal liability: Business structures can remove your personal liability as an owner, protecting you from business debts and legal concerns.
  • Business tax implications: You may file your business profits and losses on your personal tax return, or you may need to follow pass-through taxation depending on the framework you choose.
  • Decision-making flexibility: Business entities with enhanced liability protection generally come with stricter reporting regulations and less managerial flexibility.
  • Investment opportunities: Certain business entities appear more appealing to potential investors, which can be helpful when you need upfront capital.

The Main Legal Structures for Businesses and How They Differ

Now that you know the answer to “What is the legal structure of a business?” let’s go over your options. Below are the primary frameworks you can choose from, along with their advantages and disadvantages:

Sole Proprietorship

A sole proprietorship is a standard structure where one individual owns the business and runs the entire company. As a sole proprietor, you would retain complete control over the company and would enjoy relatively straightforward tax requirements, with all profits and losses going through your personal tax returns. This framework may seem appealing to some entrepreneurs given the simple setup process, but be warned that it comes with one of the highest levels of liability.

Sole proprietorships often render you liable for any legal obligations relating to the business and debts. If the company goes bankrupt, for example, this could place your personal assets at risk. Given these potential complications, investors might steer clear of this venture, meaning it can be challenging to raise capital.

Partnership

A partnership business forms when multiple parties share managerial and ownership responsibilities. This business structure is relatively simple and operates similarly to sole proprietorships, where taxation reports back to each individual’s tax returns.

You can choose from two types of partnerships: general and limited. With general partnerships, both partners share unlimited liability, meaning they will be personally liable for business debts and other complications. In limited partnerships, the primary partners still hold unlimited liability, but some partners may share limited liability, depending on their investment in the business, which can potentially protect them from business debts.

Partnerships can introduce liability risks and may raise conflicts between managerial parties who must share the decision-making responsibility.

Limited Liability Company (LLC)

When asking, “What is the legal structure of a business?” LLCs are often the first thing that comes to mind.

Limited liability companies are popular options for many ventures as they offer the flexibility and relative simplicity of a partnership with the liability protection of a corporation. With an LLC, your personal assets as a business owner are separated from the business entity, meaning you will not hold personal liability over the business’s debts or legal responsibilities. While you’re a business owner, you’re legally seen as a member, so you won’t be personally liable if the company is sued or files for bankruptcy.

LLCs also offer tax benefits as they typically follow a pass-through taxation structure but can also be taxed following the corporation model. To form an LLC, you must complete complex paperwork and fulfill filing fees, making the process more difficult than the options we’ve discussed thus far. Upon completing this, you can enjoy added flexibility, as LLCs may be managed by chosen managers or owners.

Corporation

A corporation structure is a legal entity that’s been separated entirely from its shareholders. Corporations offer robust liability protection but come with complex regulatory compliance requirements and administrative formalities.

Corporations come in two structures. C-corporations are common for large entities as they can issue multiple classes of stocks to investors and provide tax-deductible benefits. However, they come with time-consuming reporting requirements and are subject to “double taxes” since shareholders will face taxation.

S-corporations follow pass-through taxation, allowing them to avoid the issue of double taxation, but they come with many restrictions on shareholders.

Corporations are generally expensive and challenging to maintain, so they’re ideal for businesses planning to grow significantly.

Cooperative

A cooperative (co-op) involves multiple members pooling money together so they can share business benefits and profits. Co-ops often serve functional purposes, where members work together to serve each others’ everyday needs. Common examples of co-ops include credit unions or farming associations.

Co-op members share decision-making authority and operate democratically. Because of this community-directed structure, these businesses require a high level of collaboration and only work in specific scenarios.

Choosing the Right Legal Structure for Your Business: Key Factors To Consider

As you can see, understanding your options for business legal structures and how each framework varies is foundational. As you evaluate which structure to choose for your venture, consider the following:

  • The level of personal liability you’re willing to assume
  • Your preferred tax implications
  • Long-term business growth goals
  • Business flexibility and maintenance preferences
  • Your investment needs
  • Your upfront capital

Do You Need Help Forming Your Business?

We’ve answered, “What is the legal structure of a business?” but that’s just the first step of registering your business. For help with the rest, contact Thomas N. Scheffel & Associates, P.C., at (303) 759-5937 to consult an experienced business attorney today.