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Some of you may be installers working for a company right now, and you might be thinking about starting your own business. The allure of being your own boss can be tempting. You might even think that your boss or company really does not understand the market and that you can do better on your own. Whatever the reason, you want to take the next step. You have seen things like "LLC" and "Corp" at the end of company names, but you do not really know what those are or whether you even need to worry about it. Let's take a look at the advantages and disadvantages of three business entities.
Sole Proprietorship: You Are a Business
If you were just to open your doors and hang out a sign tomorrow, you would be engaged in what is known as a "sole proprietorship." That's basically just a fancy way of saying that you are your business, and it is you. There is no separation between the two. Sole proprietorships are easy to start because you do not have to do anything special to have one. You get a phone number. If your state requires one, you have to get a contractor's license, and if your municipality requires one, you must get a business license. Each year you pay federal income taxes using "Schedule C" and similar state forms, but otherwise all of the income of the business is your income and the operation is simple. You can even hire employees or independent contractors.
What's not to like about this? From a marketing perspective, being a sole proprietor can have limitations. Bigger companies like to do business with companies, not individuals. From a legal perspective, everything the business does is a potential liability to the owner, and often the insurance you obtain as an individual will not cover business-related liabilities. Let's say you have an employee driving a company truck and he gets into an accident with a school bus full of children, many of whom are hurt. If you do not have adequate insurance, you could lose your prize possessions, your house—potentially everything you own. Also, you really have only one option from a tax perspective, and you may not be able to take advantage of certain tax laws that pertain to businesses.
What About a Partnership?
A general partnership operates much the same way as a sole proprietorship, except that each partner is responsible for the partnership debts and liabilities. Two partners ordinarily would agree to split these liability obligations equally. But no matter what the partners agree to, their creditors are not necessarily bound to that agreement. So, one partner can rack up a lot of debt and then disappear, leaving the other partner to deal with the mess. A limited partnership provides some level of protection for some, but not all, of the partners, but these tend to be complex in operation and still have at least one general partner who bears all the risk.
LLC Versus Corp.
One of the primary advantages of a corporation or limited liability company is to provide the owners some protection from the liabilities of the company. This is because under the law these "entities" are treated as separate individuals from their owners. A creditor who does business with a corporation or a limited liability company can only look to the company to pay the debt owed. In the school bus scenario, the injured children's families would look to the company for compensation, not the individual company owners. If the company does not have sufficient money to pay those claims, it might go out of business, but generally the children's families would not be able to hold the company's owners personally responsible.
So, which of those two options is better? Neither. Corporations and limited liability companies (or "LLCs" for short) each have advantages and disadvantages. Corporations tend to have more formalities in their operation and can be far more complex. But, if the business owners are looking to raise a lot of operating capital, a corporation can be the better vehicle, particularly if there is a desire to sell shares in the company to the public. From an income tax perspective, they can either be taxed under subchapter C or S. A "C corporation" files a tax return and pays tax on its income separately from its owners. This can lead to the dreaded "double taxation" where the business pays tax on its income, and then when the owners pay themselves from that income, they, too, are taxed. An "S corporation" files a return but the income and tax liability pass through to the owners. That means the owners always pay tax on the business' income, even if that income was reinvested in the company, but there is no "double" taxation.
Limited liability companies offer their owners (called "Members") protection from business liability, and offer greater flexibility. For income tax purposes, a limited liability company can be taxed as a sole proprietorship, a partnership or an S corporation. LLCs generally are not as complicated to set up and often are easier to operate since they usually do not have the same government annual reporting requirements that a corporation has. For small business owners, an LLC tends to be the best option, because it provides the owner with needed protections but otherwise can be operated much like a sole proprietorship.
There are other advantages to operating the business as an LLC or corporation. Because an LLC or corporation is a separate being from its owner, it can be sold more easily than a sole proprietorship. If the owner of the sole proprietorship dies, the business pretty much dies, too. An LLC or corporation can continue to operate, and the owner's interest can be passed on to the owner's heirs. Or, a plan can be put into place for the company or other owners to buy the deceased owner's interests—which can be a "win-win" because the heirs who might not know or be interested in operating the business can get the cash, and the remaining owners can retain control of the business operations and not have to deal with an heir with no experience in the business interfering with continued operations.
Find the Right Path
Ultimately, the decision on whether to operate as a sole proprietorship, partnership, LLC or corporation depends upon your business needs and objectives. No two businesses ever operate in exactly the same way. It is also possible to start as a sole proprietorship and then change to an LLC or corporation at a later date, though all business operations prior to the conversion will not be covered by the protections of the LLC or corporation. Savvy business owners hire a good business lawyer and a good accountant to work together with the owner. In that way, the owner can identify and prioritize objectives and the lawyer/accountant team can then work together to accomplish the owner's objectives. Having that team in place is useful, too, because business and tax laws change, and the needs and the desires of the business change. When those changes occur, a successful team can adapt the business to keep it going down the right path.
