Understanding Each Business Structure: Choosing the Right One for Your Online Business
Before launching an online business, there are a number of formative decisions you’ll need to make: What will you call your business? How will you market it? Which online platform will you use for your e-commerce offerings?
There’s also the important question of how you’ll structure your business from a legal standpoint. While this may not sound like the flashiest or the most fun decision you’ll ever make, it actually has major ramifications for the future success of your online enterprise.
Why Does Your Business Structure Matter?
In fact, the business structure you choose will affect your online business in a number of different ways. Consider just a few examples:
- The legal structure you choose will determine the options you have for reporting to the IRS, and the level of tax exposure you face.
- Legal structure also affects your level of personal liability, which means it can potentially make a big difference should you ever be sued.
- The legal structure you choose for your online business will also affect the kinds of funding available to you, including financing as well as third-party investments.
For these and many other reasons, the choice over legal structure is not one you’ll want to make lightly. On the contrary, it’s important to size up each of the options available before making your determination.
The Basic Options: Sole Proprietorship and Partnership
With that said, let’s start by noting some of the basic options for legal structure.
When you first begin generating any kind of income on the basis of self-employment, the government automatically classifies you as a sole proprietor. A Sole Proprietorship is a business that is owned and operated by a single person. In other words, you get to make all the decisions yourself, and claim all the profits.
But of course, that also means you take on all the liabilities. And if litigation comes your way, there is no shield in place; the lawsuit will target not just your business but you specifically.
Another basic option to consider is a Partnership. For all intents and purposes this is the same as a Sole Proprietorship, including the same pros and cons. The distinction is, you can split duties, profits, and liabilities with one or more business partners.
Forming a Corporation
At the other end of the spectrum, you could structure your online business as a Corporation. By doing so, you’re actually creating a new legal entity, distinct from yourself. In the eyes of the law, a Corporation is its own thing, which is not the case with Sole Proprietorships and Partnerships.
There are a number of reasons why forming a Corporation might be advantageous. For example, you have legal liability protections, which can protect your personal wealth from litigation and from creditors. You can also issue shares, bringing in third-party investors. If you ever want to go public with your online business, forming a Corporation is a must.
With that said, there are also some drawbacks. Corporations face heavy regulatory burdens. For example, you’ll be required to hold annual shareholder meetings, and you’ll be required to publicly disclose your financial standing each year. You’ll certainly give up some of your control over the business.
Another issue is taxation. Most Corporations are hit with double taxation. This means that the business itself pays taxes on its earnings, and then shareholders pay taxes again on the dividends that they claim. For this and other reasons, a Corporation may not be as desirable, especially for online businesses that wish to remain small and nimble.
Limited Liability Companies: The Best of Both Worlds?
For many business owners, the Limited Liability Company, or LLC, represents the most advantageous option. It is something of a middle-ground, offering the robust personal liability protections you’d get from a Corporation, but with the flexibility of a Sole Proprietorship.
An LLC does establish a distinct legal entity, allowing you to keep personal assets and liabilities separate from business ones. With that said, LLCs do not face nearly as much regulatory overhead as a Corporation.
The Benefits of Forming an LLC
There are a number of reasons why the LLC format might make the most sense for your online business.
- Personal liability protection. First and foremost, you can shield personal or family assets from litigation and from creditors. Personal liability protection is especially important in the litigious world of online entrepreneurship.
- Enhanced professional credibility. Another reason to register as an LLC is that it confers a sense of professional credibility on your business, making it clear that you take your company seriously. This can help you as you seek financing or court investors.
- Tax flexibility. With an LLC, you can choose to be taxed on a pass-through basis, meaning you simply declare your share of the profits and pay your normal tax rate. This allows you to avoid the double taxation that plagues Corporations.
- Ease and flexibility. Starting an LLC is pretty simple, and the regulatory overhead is quite minimal. You don’t have to worry about issuing shares, holding annual meetings, or making major financial disclosures.
None of this is meant to suggest that LLCs are right for everyone; for example, if you really want to bring in investors, the Corporation provides you with more options. For a majority of online business owners, however, the LLC is the most desirable option.
Registering an LLC
The steps for registering an LLC can vary by state, but usually the process follows this basic trajectory.
- Choose the state where you’ll register. Generally, it’s best to choose the state where you’re headquartered. If you don’t live in the US, you might wish to shop around and see how different states stack up with respect to taxes, regulation, etc.
- Appoint a Registered Agent. You are required to pick a person or an individual who will receive legal and tax documents on your behalf. A physical mailing address in your state of registry is mandatory, e.g., forming an LLC in Florida means finding a Registered Agent who has an address in the Sunshine State.
- File Articles of Organization. This is the name of the legal document you’ll file with your Secretary of State in order to formalize your LLC. You will also need to pay a small registration fee.
- Create an Operating Agreement. This is a document that outlines how you’ll handle the operations and the profit allocation at your LLC. It’s especially important if you’re bringing in partners.
- Claim an EIN. You will need an Employer Identification Number from the IRS. This is available for free, and is necessary before you can administer payroll or file your taxes.
With these basic steps, you’ll be up and running with your LLC!
Choose Wisely
The bottom line: When launching a new online business, there are many decision points to weigh. The decision over legal structure is one of the most essential. And in a majority of instances, the LLC format is the way forward.
