So your business is no longer just a hobby but an actual, ongoing moneymaking venture. Congratulations! But you’ve got some homework: deciding what type of business entity you would like to form under your state’s business laws.
“Wait, what if I’m not ready or even interested in choosing a business entity yet?” you might be asking at this point. Well, as the old song lyrics go, “if you choose not to decide, you still have made a choice.” In the case of an emerging business, that de facto choice (meaning the entity that the law will impose on you if you do not take other steps) will likely be a sole proprietorship or a general partnership, but there may be a myriad of reasons why those are not the best entity options for your business in the short- or long-term.
How Much Liability Will You Have?
Depending on your choice of business entity, you could up being personally liable on the debts made against your business, including large court judgments. What this means is that, even if you have only $5,000 invested in your pilates studio, but you are hit with a $100,000 personal injury suit after your first client ruptures a disc, you might still be personally liable on the remaining $95,000. In other words, having your business declare bankruptcy may not shield you from creditors. If you are running a tutoring business, maybe you are less worried about lawsuits than if you are running a gym or restaurant, but every business can be subject to unexpected lawsuits. Entities such as LLCs and S-Corps can limit your personal liability.
Ownership Structure: Who Owns What?
Assuming you have other owners besides yourself on board, your choice of entity will in part determine the ownership structure of your business and vice versa. If you are running a business with others but without an agreement or filing with the state, the state may see you as a general partnership and the courts may impose a certain profit- or loss-sharing on your business regardless of what you thought was the agreement. For example, you may have meant for your business to be a 75/25 operation, but a court could impose a 50/50 structure. Furthermore, more complicated ownership structures may disqualify you from choosing certain types of entities as your formation option.
Who Gets to Make Decisions?
Do you want partners to each have the ability to make decisions on their own which bind the company? Would you rather have a board of directors elected by shareholders which then appoints executives to make these decisions? These are just a few of the issues you will want to address in choosing your type of entity.
At the end of the day (or at the end of the year, as the case may be), no matter how much you are in love with your work, whether or not you get to keep pursuing that work is going to depend upon the profits that you are able to take home. The taxation rates and rules that will apply to your company and personal profits can vary greatly depending on the type of entity you form. For example, a business corporation must pay corporate tax rates, and shareholders will pay a second tax on dividends, whereas an LLC allows the owners to receive all profits as personal income and an S-Corp allows some profits to be taxed only as dividends.
Legal Guidance in Building Your Business
At The Gouchev Law Firm in New York, we work with businesses of all sizes, including start-ups and franchise businesses, across New York City and New Jersey, in meeting all types of transactional needs. Call us at (212) 537-9209 or schedule a free strategy session today to see what The Gouchev Law Firm can do for your business.