Before you start any new business, you have two very important questions you have to answer before you can open the shop doors:
The first question is: Are you going to be the only owner (sole proprietor,) or will you have one or more partners in your business?
The second question is: What type of legal entity will you use as the foundation of your business?
If you are starting your business alone, or with a partner, or more than one partner, there are advantages and drawbacks to each form of business. Here are the main types:
1) A “Sole Proprietor” means that the owner is not separate (legally-speaking) from the company he runs. If the company has debts, then the proprietor has those same debts. Likewise, if the company turns huge profits, then the owner makes big profits, and has no-one else he has to share them with (save the government, of course.) The business (since it is not a separate legal entity from the owner, does not file a separate tax return.
2) If you go into business with someone else, you have what is known as a “Partnership.” A Partnership consists of two or more individuals who share equally the responsibilities of the business, but also share in the profits. The business is taxed separately from the partners, but any partner can be held liable for any amount of the debts incurred by the business. This is why it is important to have a written partnership agreement, in order to spell out the distribution of profits and losses experienced by the business.
3) Limited Partnership: A limited partnership is a lot like a partnership, except that limited partners to a business have limited liability, but also limited profit. They may only be liable for losses of the business, up to the amount they have invested. There are usually general partners (as with any other partnership, along with limited partners.
4) A corporation is a legally-defined entity completely separate from the persons that formed the business. Corporations generally sell small slices of their business to owners who wish to invest in the company, and those co-owners are called, “shareholders.” A corporation is taxed differently from its shareholders. Usually, the shareholders will elect a Board of Directors who oversee the operations, who then hire managers to run the day-to-day business. (In small corporations, the shareholders, directors and employees may all be the same people!)
5) An “S” Corporation is a different type of corporation, in that it does not pay any federal taxes, as do normal corporations. Instead, profits (and losses) are shared equally among the owners (shareholders), who then file their tax paperwork based on their individual incomes. There are a few cases where being an “S” corporation is better than a normal corporation.
6) A Limited Liability Company (or LLC), is a type of corporation that has limited liability for its owners. It is a hybrid between a regular corporation and an “S” corporation, however, LLCs may have a difficult time raising start up capital due to its lack of liability. However, LLCs are a lot less expensive to start than a true corporation.
Whether you choose to be the sole proprietor of your own business, or you want to engage other partners who will be willing to help you carry the load, you need to decide on the business model that is right for you