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How to Choose the Right Legal Entity: Tips for Selecting Your Business Structure

Commercial & Corporate Law

updated:
3.15.21
what is a corporation

Many people dream of starting their own Colorado business and being their own boss. The entrepreneurial spirit runs deep in some. But which legal entity is right for your business?

Read on to learn about the different types of business entities, along with the pros and cons of each.

Why Does the Choice of Business Structure Matter?

The business legal structure that you choose can have significant ramifications on your business. It can even affect your bottom line. What type of business entity you use will impact how difficult it is to start your business, how you pay taxes, and how well your personal assets are protected, among other things.

Some business structures can help shield you from liability by separating your assets from those of your business. This is an especially important consideration with a business that may carry risks to clients, or businesses that have stringent regulatory requirements. Both of those scenarios could expose you to lawsuits that can be devastating.

But liability isn’t the only concern. Your business structure will lay the foundation for your business to grow, so it’s important to consider every factor that may be impacted by your choice of structure.

These are some of the important business issues that can be affected by the business structure you choose:

  • How taxes are paid, by the individual or at the corporate level;
  • How much protection do your personal assets receive;
  • How much paperwork is necessary to create your business;
  • How complicated the business structure is;
  • Whether your new business should be registered with the state.

These are important elements of your business and should be discussed with the corporate and commercial business law attorneys at Sequoia Legal. Our Denver business registration lawyers can guide you in choosing the right legal structure for your new company to best manage taxes, liability, complexity, and your future plans.

What Type of Entity Is Best for My Business?

Choosing the best type of entity for your business depends upon many things, but the initial question you have to ask is what is the best type of business entity for you?

Consider the following questions:

  • Is limited liability protection of your assets most important?
  • How big is your company going to be? How many employees will it have? 
  • Will there be other investors or partners?
  • How important are tax implications to you?

By answering these questions, you can focus on the business legal structure that best suits your needs.

Each structure has aspects that might work with your plans or might not be necessary. Here are the differences among the major business legal structures you should consider.

Differences in Business Entities

what is a sole proprietorship

Sole Proprietorship

What is a sole proprietorship? First off, it’s the easiest type of business to set up. All it requires is you decide that you’re going to start a business and then do it. It’s owned and run only by you.

The downside is that there’s no distinction between you and the business, so there’s no liability protection against someone coming after your personal assets in a lawsuit.

But a sole proprietorship also doesn’t require any type of filing with the state of Colorado to be legal.

General Partnership

What is a general partnership? A general partnership can be as simple as a handshake deal between you and another person (or people). You don’t need to file any type of registration with the state of Colorado to have a general partnership.

Although it’s not necessary, partners can sign a partnership agreement that outlines each person’s responsibilities. Partners share equally in the profits and liabilities of the partnership.

A downside to a general partnership is that there’s no liability protection. You and your personal assets are at risk for any actions taken by you or your partner. In theory, your assets could be subject to a lawsuit stemming from your partner’s activities.

Limited Liability Company (LLC)

What is an LLC? LLC stands for limited liability company, and it’s one of the most popular types of business legal structures. It’s perfect for small to medium companies that want the ease of use of a general partnership but also want more liability protections.

You have to file a specific form with the state of Colorado and pay a registration fee, but formally establishing the LLC with the state is fairly easy.

LLC Basic Structure

Owners of the business are called members. The LLC can have just one member or many, and some members can be other business entities. 

Although it’s not required by law, many LLCs draft an operating agreement that details how the company will run, member responsibilities, and procedures for when members disagree. The operating agreement can be changed at any time.

One of the main differences between an LLC and a sole proprietorship or general partnership is that an LLC provides liability protection for its members. An LLC protects members’ personal assets from debts and liability within the LLC or from other members.

LLC Tax Considerations

Another benefit of LLCs is how the profits of the company are taxed. LLCs are considered “pass-through” taxation entities because profits are not taxed at the company level but passed through to the members, who are then taxed as individuals. This can mean tax savings for members and also protects against double taxation.

Corporation

What is a corporation? A corporation is the most complex business structure to establish. Corporations are separate legal entities owned by shareholders. Because it is a separate entity, a corporation provides the most liability protection for the shareholder owners.

Corporations require a board of directors and corporate officers. They can also be expanded into large entities offering shares of ownership that can be traded on the stock exchanges.

The major downside for a corporation is how it is taxed. Corporations are subjected to “double taxation”. In this scenario, the corporation has to pay taxes on its profits, then when those profits are passed to shareholders via dividends, the shareholders also have to pay taxes on their earnings.

Cooperative

What is a cooperative? Cooperatives are more commonly called co-ops and are entities owned by their customers. The people who benefit from the company are also the owners of the co-op and, quite often, are the workers in the company as well.

A good example of a co-op is a neighborhood farmer’s market where the food is grown on a plot of land and worked by the members of the neighborhood. But cooperatives can be large businesses as well. In many cases, cooperatives limit who can shop at the business or they may offer perks to members.

Differences in S-Corp and C-Corp Tax Treatment

S-corp or C-corp refers to the status of a business in terms of taxation. When they’re created, corporations and LLCs choose how to pay their taxes. 

S-corp designation allows pass-through taxation, but there are many restrictions as to which entities can make this election. 

The c-corp status allows for double taxation. 

Get Help with Setting Up Your Colorado Business

The corporate and commercial lawyers at Sequoia Legal help people fulfill their dreams of starting a business and being their boss. We can answer all of your questions and get you set up to start growing your business.

Contact us today to set up an initial consultation.

Andrew Lopez

Andrew is the founder and managing member of Sequoia Legal, LLC headquartered in Denver. He advises domestic and foreign companies and organizations, entrepreneurs and individuals on a variety of corporate and international regulatory and transactional matters

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