The foundation of a successful business is a solid legal structure.
Choosing the right legal framework protects your personal assets and significantly impacts your operations, taxes, and liability.
So, if you're an entrepreneur looking to restructure your existing business, it’s best to consider the legal structure of your business plan from the start.
Need more clarification about business plan legal structures and how to choose the right one for your business? We have you covered!
In this blog, you'll explore the types of business structures and learn how to select the best legal structure of a business.
But first, let's understand the legal structure of a business plan.
What is a legal structure in a business plan?
The legal structure in a business plan explains how your business is recognized and organized in the eyes of the law. It also shows the type of ownership your business has, whether it’s a partnership firm, sole proprietary, or LLP.
The structure determines key aspects of your business, which include:
- Taxation
- Liability for debts
- Legal responsibilities
- Distribution of profit and loss
The main purpose of legal structure in a business plan is to provide clarity and direction for your business's operations and governance. Choosing the right legal structure is crucial, as it directly impacts your business's future.
Fun Fact: The sole proprietorship is the simplest business structure and that outnumbers all other types combined. It’s like the hardworking bee of the business world—often unnoticed but highly effective.
5 common types of legal structures for businesses
Understanding legal structures is crucial as each structure affects how you operate and grow your business.
Hence, here’s the list of common types of legal structures for businesses for your reference:
1) Sole proprietorship
| Tax Form | Schedule C (Form 1040) |
|---|---|
| Liability | Unlimited personal liability |
| Taxation | Profits are reported on the owner's personal tax return |
| Management control | Full control by the owner |
A sole proprietorship is business owned and operated by one individual. The owner has complete control and is personally responsible for all business debts and obligations. There’s no legal distinction between the owner and the business.
A sole proprietorship is the most straightforward and most affordable structure to set up, requiring minimal paperwork.
2) Partnership
| Tax Form | Form 1065 |
|---|---|
| Liability | Shared liability |
| Taxation | Pass-through (personal tax) |
| Management control | Shared between partners |
A partnership involves two or more individuals who manage and operate a business together, as well as share profits and liabilities.
There are two main types of partnerships:
General partnership: It’s where all business partners manage the business and share liabilities.
Limited partnership: A partnership where some partners invest without taking an active role in management.
3) Limited Liability Company (LLC)
| Tax Form | Form 1065 or Form 8832 (if electing corporate tax) |
|---|---|
| Liability | Limited liability for members |
| Taxation | Pass-through (default); can elect corporate tax |
| Management control | Managed by members or designated managers |
An LLC is a hybrid business structure that combines elements of partnerships and corporations. It provides the liability protection of a corporation with the tax benefits of a sole proprietorship or partnership.
A limited liability company allows unlimited members, making it suitable for small and large businesses. Notably, the owners aren’t personally liable for business debts beyond their investment in the company.
4) Corporation
| Tax Form | Article of incorporation |
|---|---|
| Liability | Limited liability for shareholders |
| Taxation | Double taxation (corporate and personal levels) |
| Management control | Managed by the board of directors |
A corporation is a legal structure that treats a business as separate from its owners, known as shareholders. This means the corporation can own property, enter contracts, and be responsible for its debts rather than the individual owners.
There are two common types of corporation:
C corporation: This is a standard type of corporation. It doesn’t have a limit on the number of shareholders. However, it faces double taxation, with profits and dividends taxed at the corporate level.
S corporation: This corporation is limited to 100 shareholders. It offers the same legal protection as a C Corporation but has the tax benefits of a partnership.
5) Limited Liability Partnership (LLP)
| Tax Form | Form 1065 |
|---|---|
| Liability | Limited liabilities for partners |
| Taxation | Pass-through taxation (personal tax return) |
| Management control | Shared between partners |
A Limited Liability Partnership (LLP) is a business structure that combines the features of both partnerships and corporations.
It provides limited liability protection to its partners while allowing them to manage the business directly. This means the partners are only responsible for the business's debts up to the amount they invested, and their personal finances remain protected.
Due to their flexibility and liability protection, LLPs are particularly popular among professional service firms, such as law and accounting firms.
How to choose the right legal structure for your business?
Choosing the right business structure is essential for your business sustainability as it directly impacts your taxes, personal assets, and liabilities.
Here’s a table that provides an overview of each legal structure, so you choose the best fit for your business.
| Legal Structure | Best for Business Size | Ownership Flexibility | Funding Options | Regulatory Complexity |
|---|---|---|---|---|
| Sole Proprietorship | Small, single-owner | Only one owner | Limited to personal funds | Minimal paperwork and regulations |
| Partnership | Small to medium | Flexible with two or more owners | Easier to raise capital among partners | Requires partnership agreements |
| LLP (Limited Liability Partnership) | Small to medium | Flexible, with limited liability for partners | Partners contribute funds | Moderate complexity, requires state filings |
| LLC (Limited Liability Company) | Small to large | Flexible with unlimited members | Personal funds, outside investors | Moderate paperwork, state regulations |
| C Corporation | Medium to large | Unlimited shareholders | Easy to raise capital through stock | High complexity with strict regulations |
| S Corporation | Small to medium | Up to 100 shareholders, U.S. citizens only | Limited to specific investor types | Moderate complexity, tax filings required |
Besides the above factors, when choosing a legal structure, assess your business goals, the level of risk you’re willing to take, and how you plan to grow. Think about factors such as owner liability, tax implications, and the ability to raise capital.
For instance, if you aim for significant growth and seek outside investors, a corporation might be beneficial. Conversely, a sole proprietorship or LLC might be more suitable if you prefer simplicity and control with lower risks.
Examples of legal structure in a business plan
A well-crafted legal structure can help your business prosper and provide sustainability. Here are some examples that demonstrate how to write a legal structure in your business plan:
Example 1
Firm Name - TechSavvy Solutions
Legal Structure - S corporation
Our business, TechSavvy Solutions, a software development company, will be structured as an S Corporation. This legal structure was selected to provide personal liability protection for the owners while offering tax advantages, as profits and losses will pass through directly to the shareholders' income taxes, avoiding corporate-level taxation.
As an S Corp, TechSavvy Solutions will have a maximum of 100 shareholders, all of whom must be U.S. citizens or resident aliens. The company will be owned by three co-founders - Mitchael Marshal, Jane Smith, and Michael Johnson - who will hold an equal number of shares. This setup supports our goal of maintaining strong financial transparency while scaling operations over time.
Example 2
Firm Name - FreshBites Catering
Legal Structure - Sole proprietorship
A local catering business named FreshBites Catering will operate as a sole proprietorship owned and managed by Sophia Miller. This simple structure was chosen for its ease of setup and minimal legal requirements, allowing Sophia to focus on building her business. As a sole proprietor, Sophia will have complete control over business decisions and report all profits and losses on her tax return.
While a sole proprietorship provides no legal distinction between the business and its owner, Sophia's catering business will have a separate business name and bank account. She will also obtain the necessary licenses and permits to operate in her local jurisdiction. The sole proprietorship structure is well-suited for Sophia's immediate needs, but she may consider transitioning to a more complex structure, such as an LLC, as the business grows.
Example 3
Firm Name - Blue Horizon Travel
Legal Structure - Limited Liability Company (LLC)
Blue Horizon Travel will be organized as a Limited Liability Company (LLC). The owners chose this structure to protect their liability. It will allow tax flexibility, business income to pass through to the owners' income taxes, and avoid corporate taxation.
Blue Horizon Travel will be owned and managed as an LLC by two partners, Ally Smith and John Williams, who have equal ownership and decision-making authority. The LLC structure also allows us to bring in additional members in the future, which aligns with our long-term growth strategy.
Wrapping up
In this blog, we explored the types of business structures you can use as the foundation for building and organizing your business. With complete information, you can confidently choose the one that aligns with your goals, size, and operational needs.
However, if you still need help creating a well-structured business plan that includes legal considerations, you can use, Bizplanr. It’s an innovative tool that leverages AI capability to guide you through the process of crafting a comprehensive business plan align to legal structures in under 10 minutes!
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Frequently Asked Questions
What is the best legal structure for a small business?
The best legal structure for a small business is often a Limited Liability Company (LLC). It offers personal liability protection for the owners while providing flexibility in management and tax options. It’s easy to set up and maintain, making it ideal for small businesses.
What legal structure is best for getting investors?
For attracting investors, a C Corporation is typically the best choice. It can issue multiple classes of stock, allowing for more flexible investment opportunities. They also provide limited liability protection, which appeals to potential investors.
Can I change my business structure after forming the company?
Yes, you can change your business structure after forming the company. However, this process may involve additional paperwork, legal requirements, and potential tax implications, so it’s essential to consult a professional.
Do I need a lawyer to set up my business structure?
While you don’t necessarily need a lawyer to set up your business structure, it’s highly recommended. A lawyer can provide valuable guidance, ensure compliance with local laws, and help you avoid costly mistakes during the setup process.
What legal structure should I choose for a family business?
An LLC or a partnership is often a good choice for a family business. Both structures allow for flexible management and profit-sharing while protecting personal assets from business liabilities. The choice depends on your specific needs and how you plan to involve family members in the business.
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