Businesses go through changes all the time, and business owners must be willing to do whatever it takes to keep afloat. For small businesses that are on the brink of growth, one of the biggest changes they must consider is changing their structure. As most small businesses begin as sole proprietorships and partnerships, a business legal entity may be more beneficial in the long run.
There are many situations in which it makes sense to reconsider your business structure. Here are some of them:
More often than not, business owners start their ventures as a sole proprietorship. After all, it’s the structure that is the simplest to set up and run. However the U.S. Chamber of Commerce points out that it’s also the entity that carries a lot of risks. The owner will be personally liable for the debts and obligations of the business, so if the company, for instance, were to be sued by an individual or organization the founders will have to pay the price out of their own pocket. And as a business scales the risk of legal issues affecting the company increases. If you want to lower your liability, switch the business to its own legal entity so you can be protected in the event that the company runs into some kind of legal or financial trouble.
Another big motivator as to why business owners reconsider business structures is tax. If you’re a sole proprietor, there is no separation between you and your business, meaning you are obliged to report your business income on your personal tax returns. All your profits are then subject to self-employment taxes. However, if you form a limited liability company (LLC) you’ll be able to lower your self-employment tax obligation. A guide to forming an LLC by ZenBusiness points out that LLC owners only pay taxes on profits earned by the business through their individual tax returns, dodging what is known as double taxation. Additionally, LLC owners are also eligible for the Qualified Business Income deduction, affording them a 20% deduction from their business net income on top of the normal business expense deductions.
Greater business credibility
For sole proprietors who want to be taken more seriously by consumers and clients, Business.com outlines that changing to a strong and more flexible legal structure allows for greater business credibility. Having “LLC” or “Inc.” after the business name can do wonders for your venture, as it changes the way customers and stakeholders view your business. Granted, having those letters doesn’t automatically demonstrate your competency, but they may help in changing public perception.
If your business is growing and needs to hire more employees, operate in overseas markets, change product functions, or secure contracts with larger businesses, then it only makes sense to switch to a different entity—one that would accommodate your growth. For example, if your retail business moved on to bigger contractors and vendors, changing your entity would not only offer you increased liability protection, but also elevate your reputation in the industry. This is why many retail businesses become corporations once they reach a certain level. It allows them to acquire investors that will help the company become international. Take stock of your business and see if your current structure is still beneficial for you in the long run. If you think you’ve outgrown it, don’t hesitate to reconsider other options.
Widen your financing options
Lastly, if you want financial institutions and investors to take you seriously, you need to set up a formal business structure instead of operating as a sole proprietorship. More often than not, banks prefer loaning money to those that have a complex business structure because they’re less risky and, as mentioned, better protected. Creating a formal entity demonstrates a level of legitimacy, and it shows that you mean business. And if you are a corporation, investors can buy shares that will further increase your business’ finances, giving you the foundation to move forward.
For more tips and insights on running a business, head on over to our Business section.
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