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When launching your own business there are many decisions to make ranging from minute details to “make-or-break” enormous ones. Will you have an office location? Will you hire an accountant or bookkeeper? Will you have red or blue ink on your business card? Will you work only on weekdays? Will you target residential or commercial customers? The list goes on and on. While some of these decisions will have a small impact on the future of your enterprise, reaching a conclusion about your business model and ownership structure is one of the biggest and most important decisions you’ll have to make.
Maybe you’ve totally got these decisions in the bag and know exactly how you’ll move forward, but for many entrepreneurs this process can seem confusing and overwhelming. Not to be misleading, these are huge decisions with many little details woven throughout, but it’s not nearly as intimidating as you might think if you just have a little background knowledge. Luckily for you that’s exactly what you’ll be armed with after reading this post.
Sole Proprietorship
As opposed to many of the other terms and options, the name here kind of explains itself. If you plan on being “where the buck stops” then this is the structure for you. As owner, boss, manager, foreman, or whatever term (or combination thereof) you’ll call yourself, you won’t have to debate decisions with anyone or worry about their standards and performance, because if you find yourself displeased with someone’s actions or performance, you’ll have the ability to dismiss them without repercussions. That sounds like an easy way to avoid conflict and it can definitely have its advantages, but on the flip side, don’t fool yourself into thinking it’s always easy to be flying solo. What happens if you’re sick or injured for an extended period? There is no one there to automatically pick up the reigns and move forward. What happens if you’re facing a major decision? While you don’t have to answer to anyone else, you also don’t have anyone else to share in the weight of responsibility. Maybe you’re really good at pouring footers and driving nails but your people skills are a bit rusty at best…as sole proprietor you’ll still have to be nice to the occasional customer-from-hell and deal with trying to convince people to select you during the bid or initial consult. In many instances, contractors simply have no need or desire to move past sole proprietorship, but do be aware that being the boss isn’t always easy; that even if you’re on vacation, you’re still technically on call and that you are responsible for making sure all the bills get paid. However, there is undoubtedly a huge sense of pride and accomplishment to say you built a business from the ground up, on your own.
Partnership
This name is also pretty indicative of what you could expect as you’d obviously be working with one or more partners. When compared to a sole proprietorship, everything about a partnership is pretty much the exact opposite, for the good and for the bad. There are a few specialty types of partnerships, but for the purpose of this article we’ll assume you’re only interested in a general partnership, which basically means you would be required to share profits, decisions, and ownership with at least one other person, which can lead to disputes and confrontations when you inevitably butt heads over a tough decision (surely contractors aren’t ever stubborn though, right?). Many times partnerships are formed when one person has the start-up funds but doesn’t want to actually handle the day-to-day work, while the other person (or people) have the ability but not the money to begin. This might be your scenario or you might be working with a spouse, friend, or sibling in completely equal roles. It is comforting to know that there is someone else’s shoulders on which burdens can rest, but partnerships have the potential to end very badly if someone becomes upset or feels they have been cheated. For you and your partner(s) protection, spending a few extra dollars to have a legal partnership agreement detailed, defined, and drawn up by an attorney is an irreplaceable investment. You would like to think that a handshake would be enough but, unfortunately, as with marriage, no one sets out in a partnership hoping or expecting it to end miserably, but they sometimes do and it will be to the benefit of all parties involved if you have a clearly drawn-out plan of what the responsibilities and rights are.
LLC
Don’t be intimidated by these initials, they simply stand for “limited liability corporation”. Obviously the sound of being limited on your liability seems like a win-win, but there is a little more to it than that. The biggest advantage of operating under a LLC is that you, as a person, are protected, because you are legally viewed as a separate entity from your business, whereas in a sole proprietorship or partnership you are seen as belonging in and of each other, meaning that if your business defaults on a loan or goes bankrupt, the bank or financiers can legally assume your personal assets, essentially meaning you could lose your home to pay off your business debts. This obviously is a huge benefit should something go wrong or end up less profitable than hoped for, however, all of these extensive legal details mean exactly that: there are more extensive legal details. LLC’s are more complicated to establish and will require more formal processes as there will be more paperwork to fill out and file, plus extra precautions will have to be taken to make sure that personal details, business, and money are kept entirely separate from business ones. (That whole “being protected” thing becomes much less reliable if a bank or court can’t see where your personal money ends and the business money begins.) It is also a much more formal organization where there can be partnership or ownership interests, which can be sold. This obviously means more money available for operating costs but increases the complications when dealing with legal matters or disputes about decisions. LLC’s will provide some tax advantages, though, as you will only be responsible for paying taxes on the portion of your income as opposed to having to pay the total amount of tax on profit generated by the entire business when you are a sole proprietor.
Corporations
There are two main types of corporations in the U.S. today, an “s-corp” and a “c-corp”. The most common type of corporation in our market is the c-corp, which provides similar benefits of an LLC in that you are shielded as a person from any judgments or rulings levied against your business. Corporations are obviously much more complicated business structures as they have shareholders and generally stocks for sale. This obviously isn’t a simple business model that would apply to “Joe’s Home Repairs” but if you’ve been in business for years and have created an impressive network of contacts and investors, you might consider moving into this business model. There are two major differences between the “s” and the “c” type corporations. First, a c-corp is usually larger, having an unlimited number of shareholders, although there are regulations on how many you can have before having to file with the SEC, the nice folks who regulate our stock exchange. In an s-corp, which is usually a smaller business, you can only have 100 shareholders and one class of stock. The second major difference is how you are viewed for taxing. Many businesses choose to be an s-corp because they can avoid the dreaded “double taxing” of a c-corp. In an s-corp you would only be taxed on the income you personally gain from the business, while shareholders also have income and losses through the business, meaning the burden of taxation is distributed among yourself and anyone else who has a stake in the business. In a c-corp however, profits are taxed when earned and then are taxed again when passed along to shareholders in the form of dividends, where shareholders cannot claim any corporate losses to offset the tax burden, as opposed to an s-corp. Corporations do have more power and credibility as they are usually such large business entities and have such huge earning potential. Obviously these business structures are not for the faint of heart or the first-timer, but it’s also useful to be armed with a better understanding of the business world around you and to know what you could potentially grow into.
My name is Jeff and I created this blog in 2007 to help and inspire contractors and home service providers. It’s come a long way since then.