The 2008 stock market crash set off what is now referred to as ‘The Great Recession’ and is responsible for millions of hard-working Americans losing their jobs. As a result, there has been a resurgence of entrepreneurial activity where people are turning money-making ideas into a small business.
How important are small businesses to America? According to the Small Business Administration (SBA), they represent 99.7% of employer firms and employ roughly half of the private sector workers. Importantly, small businesses have generated 64% of the new jobs created in the U.S. over the past 15 years. These are remarkable statistics especially when you consider that over half of these small businesses are home-based.
For a business owner, one of the most important decisions you will make is what type of entity you will use to operate your business. Your primary choices include: Sole Proprietor, Partnership, Corporation or Limited Liability Company (LLC). For the next few weeks, I’ll explore each of these business forms along with the advantages and disadvantages of each. If you are one of the millions of Americans who either own a small business or are contemplating starting one, this series may be worth millions of dollars!
Let’s begin our discussion with the two main reasons that entity selection is so important:
Liability protection. It’s unfortunate but true that here in America, we live in a very litigious society. As a business owner, consider yourself as someone walking around with a bull’s-eye on your back…you are an excellent target for a lawsuit! How do you protect yourself, your personal assets and your business? One of the ways is through the entity you choose for your business. A properly structured business entity can effectively shield your personal assets from a lawsuit against your business.
Tax benefits. If you are a ‘W2’ employee (working for someone else drawing a paycheck), your tax deduction opportunities are very limited. For most people this amounts to home mortgage interest, charitable contributions, and a few miscellaneous deductions. However if you start a business, you open the door to literally hundreds of potential tax deductions. While your primary reason to start a business should be for profits, access to massive tax deductions is certainly an excellent secondary reason. Certain types of entities will offer additional tax benefits over other types.
Sole proprietorship is the simplest and most-often used form of business comprising 80% of the businesses in America. With a sole proprietorship, you and your business are inseparable…you ARE the business.
The primary advantage of a sole proprietorship is that it’s easy and inexpensive to set up and operate. In fact, most people run their sole proprietorship out of their personal checkbook.
Perhaps the main disadvantage is that if a lawsuit arises that is related to your business, not only are all of your business assets subject to claims, but all of your personal assets are fully exposed as well.
If you’re just ‘testing’ a business idea to see if it has ‘legs’, you may want to start as a sole proprietor in order to minimize organizational set-up costs and time. As soon as you determine that you have a viable business, consider adopting one of the other business entity forms I’ll review in the coming weeks.