Starting a Business

The following are some of the important factors business owners should consider when selecting a form of ownership.

Cost of Start-Up

Setting up a business can involve little more than printing some business cards, or you could hire a corporate attorney to draft documents such as corporate charters, agreements, and articles of incorporation. As the forms of business ownership become more complex, the cost associated with establishing the business also increases. Every business owner must decide how long they want to wait before getting the business up and running and also how much of their own money to invest.

Control vs. Responsibility

One of the main reasons people give for wanting to start their own business is the desire to be independent and “be your own boss.” Different legal structures provide the owner with more or less control and authority. There are trade-offs in each case because with autonomy and control come responsibility. For instance, if you’re the sole proprietor of a business with no employees, as a one-person show, you retain all the control, but you also have all the work and responsibility. Other forms of business, such as partnerships, may mean giving up some control, but the responsibility (and liability) may be spread among several partners.

Profits—to Share or Not to Share

Many first-time business owners look to people like Bill Gates or Oprah Winfrey and aspire to their level of wealth and success. How a business’ profits are shared (or not shared) is determined by the legal structure. Some owners are willing to share the profits in exchange for assistance and support establishing and running the business. Other business owners make the conscious decision to limit the scope and nature of the business to avoid having to bring in others while retaining all of the income themselves.

Taxation

When planning to start a new business, many people instinctively seek the advice of an attorney as the first step in the process. However, no matter how large or small your business is going to be, it’s very important to get the advice of a seasoned tax professional, such as a CPA. The reason for this is that each form of business ownership is treated differently by the Internal Revenue Services (IRS) and by state and local taxing authorities. Depending on the legal structure of the business, the owner may be taxed at a lower rate than someone working for a large company. Or the owner might see their business income taxed twice, sometimes with additional specialty taxes imposed by governmental agencies. The time for a business owner to decide how heavy a tax burden they are willing to bear is at the start of the business, not on April 15 when taxes are due.

Entrepreneurial Ability

At some point you’ve probably known someone with a particular talent for something like fixing cars or baking bread and said, “You should start your own business!” For example, maybe you are a talented cake decorator, but does that necessarily mean you have the requisite knowledge, skills, and abilities to open and run a successful commercial or retail bakery?

It’s often easier said than done. Many businesses fail despite the owner’s enthusiasm and talent because the owner lacks the deep knowledge and expertise needed to transform an interest or hobby into a commercial enterprise. Performing an honest and accurate appraisal of one’s skills, background, and entrepreneurial abilities before launching a business can prevent disappointment and failure later on.

Risk Tolerance

Everyone’s tolerance for risk is different. Some people enjoy the rush of skydiving and rollercoasters, while others prefer to keep their feet on the ground. In business, your degree of risk tolerance should be compatible with the form of ownership being considered. For example, a forty-five-year-old entrepreneur with children to support might seek to protect accumulated assets (real estate, savings, retirement, etc.) and select a legal structure that carries less personal financial risk. Every prospective business owner must gauge what they are willing to risk losing and choose a form of business accordingly.

Financing

Few business owners start a business with lottery winnings or many years’ worth of savings. Many seek funding from a bank, venture capitalist, private investor, or credit union in order to get their businesses off the ground. Lenders may be one of the greatest influences on the choice of business ownership—even more decisive than the owner’s preference or ambition. Since there is risk inherent in any business venture, especially start-ups, lenders often require the business to be structured in a way that best assures the repayment of funds (whether the business makes it or not). Even businesses that have been established for a long time may be forced to change their legal structures when seeking funding to expand their operations. If an owner anticipates needing funding at any point during the life of the business, then selecting a form of ownership that aligns with lender requirements from the start may be a necessary decision.

Continuity and Transferability

Finally, business owners need to consider whether they want their business to outlive them (or carry on after they leave). If an owner is looking to start a business that can be passed on to children or other family members, then the legal structure of the business is extremely important. Certain organizational types terminate with the owner, so it’s crucial for the owner to decide how and whether a business will persist and/or be sold to new ownership.

These are just some of the considerations business owners must weigh when selecting a form of business ownership. Many of these issues require owners to look far into the future of their business and imagine countless possibilities and problems associated with being self-employed. Although it is possible to change legal structure once the business is established, the more complex the business operations are, the more complex the change will be. In some cases, the complexity of the situation can prevent the owner from making the change that’s desired. Considering as many of these factors as possible from the outset can save countless hours and great expense down the road.

In the coming sections we will explore the possible legal structures a business owner can choose and look at the advantages and disadvantages of each. We will begin with the simplest of all organizational types: the sole proprietorship.