Prior to the commencement of any large entrepreneurial project, one must go through the rigorous process of setting their business up. Although there are cases when this may only take a few days, it is not uncommon for the first-time owners to spend weeks gathering the necessary paperwork. One of the main reason for such a wide-spread spectrum is the plethora of options that people have when deciding the best business structure. Some of the more common ones are emphasized below:
- Sole proprietorship
- Limited Liability Company
The way that one goes about making a selection is based upon their field of expertise, size of the future project, amount of capital needed to get started, the risk and liability, and so on.
The Ever-Changing Nature of Business
An individual who has been around long enough to see almost every type of entity structure in person is Rusty Tweed. Thus far, he has managed and operated multiple companies that attained enough success to serve as conversation-starting topics for other entrepreneurs. According to him, almost every business structure type has its benefits and limitations, and there is a three-question pyramid that can help people decide how to set up their company.
Considering the Size-Related Restrictions
Probably the most important topic when it comes to structuring business, according to Rusty Tweed, deals with the detailed overview of the anticipated size. Is the goal to grow the business through salaried employees or will there only be occasional independent contractors? Is there a future that involves franchise-like expansions that will turn the company into a worldwide magnate? Or, does one simply wish to remain a one-fellow endeavor without bringing in any external parties?
After considering such topics, the first official question of the pyramid is: Is one person enough for the business to thrive? If the answer is yes, the entire process is immediately over and the best structure to use is a sole proprietorship. Nowadays, there are countless companies that allow people to be sole proprietors who can work remotely. For example, every Uber driver is an independent contractor who has their sole proprietorship consisting of giving rides to parties.
Enter Additional Questions
If the answer to the first question of the pyramid is no, one will not be able to take advantage of a sole proprietorship. In that case, they will now move on to the next question to better assist them with the structuring process. Generally speaking, that question will be some variation of the following: Does the business require an enormous amount of capital to get started? If the answer is yes, one will probably need to look into creating a business structure that is incorporated with the state.
Corporation, in most cases at least, is the very opposite of a sole proprietorship when it comes to the levels of simplicity and paperwork required. Unlike an independent contractor who can start running their business immediately, a corporation needs to go through a tedious process of electing officers, filing articles of incorporation, coming up with the mission, vision, and value statements, and an overabundance of other considerations. The reason why it is the best business structure for people who need a lot of capital is that it offers an “Initial Public Offering” where outsiders can give money by purchasing stocks.
The Involved Parties
If the answer to the previous question is no, Rusty Tweed advises to move on to the last question. This one deals with the estimate of how much risk is the owner willing to take and, for the purposes of having a yes-or-no question, it is: Will the owner be taking a considerable amount of liability exposure? If he will, creating a partnership and making themselves a general partner would be a good idea. In most cases, these types of entities operate through joint efforts of all the partners yet only those who are deemed “general” have the final word and carry most of the risk.
If the owner wishes to limit their liability yet needs people to join the project, which means that they answered the last question with a “no”, a limited liability company would be the best fit. These entities are based on “members” who share in the profits as well as the risk associated with the operations. Nonetheless, their exposure is a lot smaller since, unlike most partnerships, they are based on a limited responsibility for the actions of other members. Meaning, one will enjoy the profit-sharing days but not be a victim of any irresponsible behavior coming from others within the LLC.