Structuring Startup Success (OPINION)

Northwest Arkansas has always been a thriving spot for entrepreneurs.

If you’ve been here long enough, you might even remember when some of the world’s biggest enterprises were small mom-and-pop shops headquartered on one of our local downtown squares. 

Are you one of those entrepreneurs our area is so famous for? If so, then you may be trying to decide if now is a good time to take your idea to market. While timing is certainly important, it is also critical that you decide how you are going to structure your new company.

Will you open as a sole proprietor, a partnership, corporation or a limited liability corporation? If you haven’t yet decided, here are some very important differences you should first consider pertaining to legal structure, liability and tax implications that will help you make the right choice. 

 

Sole Proprietor

Operating as a sole proprietor is the most common structure for small businesses. Legally, the business is simply another representation of the owner. This can be desirable for startups because it is easy to do. Taxes are reported on personal returns and there are no legal documents that need to be filed. 

However, the business owner has no protection from liability claims filed against the company, which means all your personal assets are at risk. This legal exposure is one of the more risky aspects of sole proprietorships, but in the early stages of the business’ life, it can make sense.

Partnership

A partnership is essentially a sole proprietorship with two or more people. The business is not a separate legal entity, and the partners assume all legal and financial risk and reporting. Each partner is expected to pay his or her pro-rata share of tax due and all profits and losses are paid personally.

While a partnership can be expedient and necessary, a major risk factor in partnership scenarios is that partners can be held liable for other partners’ actions. With personal assets on the line, some people seek more protection from legal exposure when setting up their business.

 

C Corporation

Unlike sole proprietor and partnership structures, C corporations are separate legal entities. Principals in the business file official documents called “articles of incorporation” with the state and the corporation receives its own federal and state tax identification numbers. 

Because C corporations are considered their “own person” the organization assumes all legal and tax liability independent of any partners, principals or executives. C corporations can also offer pre-tax benefits to employees. Health care and 401(k) benefits are two of the most common benefits offered by corporations.

The company also will exist in perpetuity, as opposed to sole proprietor and partnership structures, which only exist as long as the principals are alive or engaged with the business. 

This protection is desirable for liability purposes but there are times when having the corporation file taxes might not be advantageous, especially in the early days of a company’s life.

 

S Corporation

An S corporation is a legal entity, like a C corporation, with one major difference. S corporations are taxed as partnerships. 

This can be desirable as the company is just starting out and financial losses are being incurred. The partners are able to write off the losses on their personal taxes and then transition the company to a C corporation when the company is on more solid financial footing.

 

Limited Liability Corporation

Limited Liability Corporations (LLC) are a relatively new creation. As the name suggests, the major benefit of operating as a LLC is the protection from liability the structure provides. The organization is taxed like a partnership and its existence is tied to the life of the owner. 

From a legal perspective, the relative newness of LLCs has meant there is not a lot of case law that sets precedents for some of the more complex legal questions that arise. This can create legal exposure for principals, but some of the more overt risks assumed under a partnership structure can be mitigated.

 

Bottom Line

Starting a new business can be one of the most exciting, challenging and opportunity-filled times of your life. While many aspects of starting a new business can be researched, there is no substitution for personal advice from experts.

Whether you have legal, tax or insurance questions it is always a good idea to get those answered by someone you trust. Ensuring your business’ foundation is strong and you are protected can make some future challenges easier to navigate. 

Alan Lane is a partner at Odom Law Firm in Fayetteville, founded in 1982 and located just off the downtown square. The firm’s seven staff attorneys handle personal injury work as well as business clients. Lane can be reached at 479-442-7575.