The Pros And Cons of Key Legal Formations

Abi Moore
September 17, 2024

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The Pros And Cons of Key Legal Formations

Hear from guest blogger, Amanda Clark, on what SMS marketing can do for your e-commerce.

When you start a new business, you’re faced with a number of critical decisions. Few of these decisions matter more over the long run than your decision about which legal formation to choose. The legal formation you choose for your business can affect virtually all aspects of your business, from how you report to the IRS to how you bring new employees on board.

Because this decision is so paramount, it’s helpful for business owners to have a clear understanding of the different options available to them and to understand the specific pros and cons of each.

Sole Proprietorship

Let’s start with the most basic option. When you start generating any kind of income on the basis of self-employed activity, you are automatically considered, in the eyes of the government, to be a sole proprietor. A sole proprietorship is a business that’s owned and operated by a single person. As the entrepreneur, you get to make all the decisions, and you get to claim all the profits. Of course, you are also on the hook for any debts or liabilities. Something that’s crucial to understand is that a sole proprietorship business formation does not have any legal existence apart from the owner. This means in essence that the owner has unlimited legal liability; any suit that’s brought against the business is really being brought against the owner. Learn more about the unique challenges and advantages of sole proprietors, including the use of communication tools like texting, and how it compares to LLCs.

Sole Proprietorship Pros and cons

Unlimited Liability / Significant Risk Exposure, Especially In Litigious Environments
Limited Capital
High Responsibility
Challenges Bringing On New Employees
Difficulty Selling or Passing Along A Business

Partnership

Another legal formation to consider when starting a business is the partnership.In many ways a partnership works like a sole proprietorship. For example, a partnership does establish a distinct legal entity that can exist beyond its practitioners. The big distinction is that instead of working solo, a partnership allows you to share duties, responsibilities, profits, and liabilities with one or more business partners.

Partnership Pros and cons

Limited Liability Company (LLC)

The Limited Liability Company, or LLC, is generally regarded as the most popular and versatile legal formation for small businesses. In many ways, it represents the best of both worlds: A chance to combine the flexibility and ease of a sole proprietorship with some of the robust personal liability protections associated with corporations (more on that shortly).

The big distinction between an LLC and a sole proprietorship (or a partnership) is that an LLC actually creates a new legal entity, one that is distinct from its owners. In other words, you can keep business assets and liabilities separate from personal ones. If you’re hit with litigation, you can keep your business interests and your personal interests separate. You can more easily recruit employees and even transfer ownership of the LLC, including as part of a succession plan.

The specifics for registering an LLC can vary by state, but as a rule of thumb, business owners will need to attend to the following steps:

Choose a state to register in.
Ensure an LLC name that isn’t already claimed by another LLC in the same state.
Appoint a registered agentwho has a mailing address in the same state (e.g., for an LLC in Texas, you’ll need an agent with a Texas address).
File articles of organization with your state, and pay the state’s registration fee.
Create an operating agreement to outline how you’ll operate your LLC.
Claim an Employer Identification Number (EIN) from the IRS.

LLC Pros and cons

Corporation

A final option to consider is legally forming a corporation. This is the option that provides the most robust personal liability protections and is the most extensive options for fundraising. However, it is also the most onerous option from a regulatory standpoint. A corporation is a distinct legal business entity that is led by a Board of Directors. Ownership may be sold or distributed in individual shares, and annual shareholder meetings are required by law.

Corporation Pros and cons

Which Formation is Right for You?

As you consider the different legal formations available to your business, remember to consider all aspects of taxation, day-to-day business operation, ability to secure funding, and the level of legal exposure you’ll be taking on. Think also about the sort of regulatory burdens you’re willing to absorb. In addition to these factors, think about the tools you’ll need to effectively manage and communicate within your business. For example, regardless of the formation you choose, having a reliable business communication solution is crucial. Services like business text Messaging and Business Phone service can enhance your communication capabilities, helping you stay connected with clients, partners, and employees efficiently. With specific questions, don’t hesitate to contact an attorney or a business coach in your area.

About the Author

Amanda E. Clark is a contributing writer to LLC University, a Benefit Company committed to creating economic value in the community through free content and courses to help you form your LLC. She has appeared as a subject matter expert on panels about content and social media marketing, as well as small business ownership.

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