Learn the basics of declaring a business entity along with the pros and cons of the most common options.

The key to any successful entrepreneurial endeavor is having a product or service you’re sure everyone’s going to love. To get from point A (ideation) to point B (growth), though, you’ll have to delve into the nittygritty of small-business ownership, including what type of entity yours will officially be. This is a crucial step that shouldn’t be taken lightly—it will help determine the overall scope of your company and affect your taxes and legal risk, among other things. Here’s a rundown of your core structuring options along with which factors to weigh when it comes to making your decision.

The basic types

In general, there are four categories that a business can fall into: a sole proprietorship, a partnership, an LLC, or a corporation. Knowing the primary differences between each can start you thinking about which one will suit your enterprise best.

Sole proprietorship
This entity type is as basic as it gets: it’s super easy to set up, and you alone own your company, meaning you have total control and get all the profits. This makes it a good dip-your-toes type of option for those coming in with minimal risk. An example of such a situation is having a craft store on Etsy or doing freelance design. The main negative is that you are the business, for better or worse, so if anything goes south (especially financially or legally), you are personally liable. In addition, outside funding may be a challenge because of this avenue’s all-or-nothing nature. A final side note: if you have a business but don’t bother to register its entity structure, it will be defaulted into this category.

Partnership
As the name indicates, a partnership has at least two owners. The most basic version is the more informal general partnership, in which each owner shares the responsibilities, assets, etc. equally. A limited partnership (LP) is more unbalanced: there’s one general partner who runs everything (and is thus legally liable for the company’s actions) and one or more limited background partners providing investments (whose liability is relatively minimal). And with a limited liability partnership (LLP), the partners are more akin to spokes on the same wheel, all sharing limited management duties, company decisions, and liability depending on how invested they are in the business; high-stakes entities, such as law offices and doctor offices, are often LLPs. Whichever you choose, be sure that each person’s role and responsibilities are spelled out in a partnership agreement.

LLC
An LLC, or limited liability company, is often considered a nice middle ground between a partnership model and a corporation, keeping all the owners more protected from personal liability while offering additional flexibility concerning taxation status. In addition to asset protection, an LLC is a great choice if you expect quick growth and/or want to build your business’s credibility; plus, setting one up isn’t usually costly or complicated. On the downside, you’re considered self-employed and have to pay Medicare and Social Security taxes.

Corporation
Becoming a corporation essentially announces that you’re at a completely different level with shareholders, directors, a board, and the like. The primary advantage is scalability. This type of entity often provides the maximum amount of exposure and growth potential, giving you more opportunities to raise venture capital and woo investors. You can also choose between an S corp and a C corp; with the former, your business profits are only taxed individually, while the latter faces double taxation. That can be balanced out, though, by the other advantages C corps get through tax breaks and profit reinvestment. Since corporations are the most complex option legally and organizationally, they’re not necessarily great for starter businesses.

Know your why

Settling on a structure can be a complicated decision, but it doesn’t have to be final. Consider your vision for your business, assessing where it currently is to decide what option may suit it best now while also looking ahead to how it may grow. Do you want to keep it as a simple small business with the same structure, or do you expect it to become larger and more complex within a few years, necessitating a switch?

For example, say you’re taking a steady approach, easing yourself into entrepreneurship by working on your idea as a side hustle in addition to your full-time job. In such a situation, there’s usually minimal risk involved, so you might opt to stay as a sole proprietorship for years until you’re ready and able to dedicate more time and resources to it, possibly becoming an LLC or bringing in partners.

As you weigh your choices, keep in mind the following factors as well. Determining which means the most to you may help you decide on the ideal fit.

Control
Best option: sole proprietorship
This is assuming, of course, that you are also willing to accept all the risk. You can still maintain a level of control in the other options, but it’ll be shared with partners and can get complicated and costly in some instances (especially with corporations).

Funding
Best option: corporation
If your success is happening at superspeed, incorporating can help with building your business’s credit and capital, especially since both an S corp and C corp can offer stock options. Just remember that you’ll be double taxed as the latter since the business is considered its own taxable entity.

Liability
Best option(s): LLC or corporation
As mentioned earlier, a partnership may offer liability protection depending on what type it is. However, you may be better off with an LLC, which offers more protection from personal liability. Corporations also boast limited liability but with some added tradeoffs, such as more oversight and paperwork.

There are many factors to consider as a new small-business owner, not the least of which is your business’s official entity structure. Make sure to do your homework and weigh the benefits and pitfalls of each option carefully before making your decision. Better yet, since the details can get tricky and laws can vary from state to state, consult a tax attorney, accountant, CPA, and/or CFP for assistance before you jump in.

TAKE ACTION:
Make a list of the pros and cons of each business-structure type to get an idea of which may be the best choice for your situation..