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Best Choice of Legal Entity for a New Business Owner?

Posted by attorney John Fazzio

Should a business owner form a corporation or an LLC? Would it be better to simply operate as a sole proprietorship? To answer these questions, an entrepreneur should ask himself:

1 – How many owners will there be?

2 – What liabilities will the company have that could come back to haunt the owners?

3 – How much capital, and what kind of capital (equity/debt) will the company need to raise?

4 – Who are the company’s customers?

In general, partnerships are disfavored because they do not provide limited liability protection for the owners, and because the partners are responsible for one another’s actions.

In general, LLCs and S-Corporations (sole proprietorships) confer many of the same benefits, and can be used interchangeably for small or growing businesses that do not have significant capital requirements. They confer limited liability, just like corporations, but do not have the disadvantage of a second level of tax.

C-Corporations are useful for larger companies that need to raise capital by providing shareholders with equity and by taking out significant debt. C-Corporations, however, are signficantly more costly from a tax perspective.

Before inquiring into what structure will best suit him, an entrepreneur should consider what his customers and his vendors will want. If you are going to be selling to Microsoft, they may want to know they are dealing with an established corporation with significant capital. Likewise, if you are going to be buying substantial inventory from vendors, you might have trouble establishing credit if you are a fledgling partnership. These issues are not a primary concern, but should be considered.

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