What Kind Of Ownership Structure Is Best For Your Online Business?
Lately I’ve been receiving a lot of questions about LLCs, corporations, and partnerships. People are confused about which ownership structure is best for their online business. Is it really necessary to make your business “official”? What are the differences between the various structures? What will happen if you don’t choose an ownership structure?
Overview of Common Ownership Structures:
Sole Proprietorship:
This is a one-person business not registered with the state. You are not required to register, file papers, or acquire documents. Basically, if you do nothing your online business with automatically be a sole proprietorship. In a sole proprietorship the business and owner are one and the same – you report your business income and losses on your personal tax return, which may or may not be a good thing for you. The negative to sole proprietorship is that you are personally responsible for business-related obligations like debts or settlements if you’re sued.
Partnership:
A partnership is like a sole proprietorship in the sense that you don’t file papers or documents. However, if you are entering into a partnership you would be wise to have some kind of contract since each partner is personally responsible for the entire amount of any business debt or claims. You’d also have a hard time recovering any resources your partner might make off with in the middle of the night if there was no contract in place.
Remeber, nobody enters into a partnership with someone they think is dishonest, yet people are ripped off by their business partners all the time. Even if your partner is your own mother, don’t leave the door open to misunderstandings and future legal issues.
Limited Partnership:
Limited Partnerships are complicated and difficult to arrange (not to mention expensive), so this probably will not be the best avenue for your average online business entrepreneur. Basically, one person or company (the general partner) creates the business and receives investments from the limited partner(s). The general partner runs the day-to-day operations of the company and is responsible for all business debts. The limited partner has minimal input but also is not responsible for business debts or claims. Profit can be split in a variety of ways.
LLC:
An LLC (Limited Liability Company) is one of the more popular options for people starting an online business (it’s certainly the option I receive the most questions about.) An LLC combines aspects of partnerships and corporations: its owners have limited liability for the company’s debts and obligations like shareholders in a corporation, but its income and losses are passed through to the owners like in a partnership.  It is much less formal and more flexible than a typical corporation.
The benefits include separating your assets so you’re protected in case your business gets sued. It also provides some tax breaks – you are only required to pay taxes on your earnings once instead of paying both corporate and individual taxes.
The downside of an LLC versus a corporation is if a member of the LLC dies, leaves, or goes bankrupt, the LLC is usually dissolved. You might consider making your online business an LLC if you want to reap the tax benefits (this would be important if you expect your earnings for the year to be quite high).
To set up an LLC, you need to file Articles of Organization with you state (usually through the Secretary of State). You can hire an attorney to do this, or you can do it yourself (there are numerous do-it-yourself kits to help with this). When I have legal/business/accounting work, I like to do it myself, then hire a lawyer or CPA to check it over. That way I only have to pay for a little of their time, but I can be sure everything is correct before I file it, saving time and money in the long run.
Corporation:
A corporation is similar to an LLC: it is an entity that exists separate from the business owner, shielding owners and shareholders from company debt and obligations. To set one up, you must complete articles of incorporation, file them with the proper state authority, and pay the requisite fees. Unlike an LLC, if an owner dies or sells his interest, a corporation continues to exit until it is formally dissolves. A corporation can also issue stock, which helps attract outside investors.
A C corporation is a standard business corporation, while an S corporation has greater strictures but allows you to avoid double taxation. An S corporation is usually the choice of small business owners and entrepreneurs who want the legal protection of a corporation, but want to be taxed as sole proprietors or partners. The strictures such as “no more than 75 stockholders” and “only one class of stock can be issued” are not a problem for your average small-business owner. All stockholders/partners have to be US citizens or permanent residents, however.
Which Should Your Average Online Business-Owner Choose?
Generally, I’d say it’s not necessary to set up your online business as a Corporation or LLC unless you’re planning on amassing a mountain of debt or getting sued. If down the road your online business vastly expands, you can change it’s ownership structure then. I would recommend seeing a lawyer if you’re entering into a partnership, however, as an undefined partnership leaves you open to a host of financial difficulties. You might want to speak to a CPA or attorney in any case before making a decision about ownership structure.
