Choosing the Right Legal Structure

When you first start a business, one of the first, if not the first, things you will do is decide what legal structure you would like the business to be. This is a very important decision that might your business in the short and long-term. Here are the most common legal structures in Kentucky, with reasons why you might decide to choose that particular structure:


Sole Proprietorship

This is the most simple and easiest business to form, because the business and the business owner are one. Most people that operate a small business on the side are sole proprietors, weather they realize it or not. Sole proprietors are the least expensive and the least complicated. In the eyes of the public and of the law, the business owner and the business are the same. The implications are that your assets are a part of the business, so there is no protection if something legally happens to you (liability protection). There are no business registration documents that you have to file. All you have to do is be responsible for taxes on the Federal, State, and Local level. If you are going to be using a different business name other than your own personal name, you may need a DBA (Doing Business As), which can be bought for under $40 at the County Clerks office. This is an ideal structure if you are just starting out your business, do not deal with the general public very much, and do not have many personal assets that you want protected.

Partnership

A partnership is very similar to a sole proprietorship, except that instead of 1 owner, there are multiple owners. The business and the owners are one in the same; there is not difference in the eyes of the public and the law. Because of this, there is not liability protection for a partnership. There are not any registration documents that you need to file to become a partnership, except for your Federal, State, and Local taxes you need to register for. I would recommend seeing your tax accountant to help you with your taxes. With a partnership, it is important to have a Partnership Agreement, which is a legally binding document that lists how decisions will be made, how profits will be shared, how a partner can get out, etc. I would recommend seeing a lawyer to help you draw up a Partnership Agreement. 

A partnership can take many forms, so it is important to dictate the form of the partnership on the Partnership Agreement. For instance, you could have a General Partnership, where all owners divide the responsibility and profit/loss equally. There is a Limited Partnership, where some owners have limited rights, responsibilities, and liability protection. This form of a partnership is more complicated and may require formal legal documents to be filed. Lastly, there is a Joint Venture, which is like a General Partnership but only for a limited time. If the owners want to continue their venture after that allotted time, they will be recognized as a General Partnership. No matter what kind of partnership is formed, it is recommended that you see a lawyer to help you get set up legally. 

Corporation

There are many types of corporations, but they are all charted by the state when the business is headquartered. Corporations are considered a unique entity by law. That means the owners and the business are separated. The business has an identity and can be taxed, sued, enter into contractual agreements, etc. Instead of using the term owners, the people who own the business are called shareholders. These shareholders own either public or private stock of the business, and elect a Board of Directors to oversee policy and strategic decisions. If the shareholders (owners) die, the business lives on. Another person can purchase the shares of stock and become a shareholder in that person's place. Corporations are a very complicated business structure and must adhere to strict guidelines and legal requirements. A lawyer is a must have if you are thinking about creating an corporation. 

Limited Liability Company/Partnership (LLC/LLP)

Like the simplicity of the sole proprietorship but hate how it doesn't have liability protection like a corporation? Well, you are in luck because the LLC is a business structure designed to provide benefits of other structures. The LLC is owned by members or managers, which can be 1 person or multiple people. The members of the LLC make strategic decisions for the company and they have to renew their LLC every year with the state. An LLC gives members liability protection, so their personal assets are protected. BUT taxes are still flowed down to the individual. If you are a single member LLC, your assets are protected, but your taxes will flow down to you personally. This means you are responsibility for paying your tax bracket, as well as the self-employment tax the Federal Government requires. The LLC can choose to elect to be taxed as a corporation, which is called a S-Corporation. Talk with your tax accountant to see if you would benefit from having your LLC elected to be taxed as a S-Corp. 


To help you decide what legal structure is best for you, you really need to know your company vision and mission. Here are a few things you need to consider in helping you decide what legal structure is best for you:

  • Your vision for the future of the company and its' size.
  • The business' vulnerability to lawsuits.
  • Expected sales revenue, profit, and loss of the business.
  • The level of control you wish to have.
  • The value of your personal assets.
  • The amount of time spent dealing with the public.

As with all the advice on this site, I encourage you to speak to an account or lawyer about legal or financial matters before you make a decision. There is not worse thing in business than making an uninformed, bad decision. Spending time thinking about legal structures, because it will have an impact on your business and your plan for future growth.