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Not Starting Off with the Right Business Type - Legal Issues for Entrepreneurs

The Huffington Post logo The Huffington Post 19/02/2016 AJ Agrawal
SUPREME COURT © Jean-nicolas Nault via Getty Images SUPREME COURT

There are many different companies in the US. Starting one is easy, but changing from one to the other later involves a whole host of complex legal issues. A lot of entrepreneurs make the mistake of not starting off with the right type of business.
This is simply because they often do not understand the various business options open to them. This guide is going to introduce you to the main business types available to you.
What is the Best Company for You?

There are so many company types for a reason. Everyone in every industry will have the best option for them. As a general rule, corporations and limited liability companies experience lower taxes. By choosing the wrong type of business you are risking higher taxes, more expenses, and the need to hire a team of personal lawyers to manage the various legal complications.
Twenty-two million of 28 million small businesses in the US are just self-employed people. Many of them run as corporations because a small business is defined as a company with fewer than 500 employees. Don't let the names and your stereotypes influence your choices.
Sole Proprietorships

There are no legal documents, fees, or filings for sole proprietorships. Outside the usual local permits for small businesses, you can set these up in a matter of hours. But there are severe limitations with this option, even for one-man companies.
If you ever need to bring in an investor, you can't do this. You also have no business protection against creditors making claims against you.
General Partnerships

General partnerships are used for companies with more than one founder. The partnership agreement is the key document with this type of company. It determines the rules and responsibilities for each co-founder, as well as what each person is entitled to.
Each co-founder is responsible for the debts of the business and they are vulnerable to claims by creditors. Again, this is another business type that leaves you vulnerable.
Letter Corporations

This article combines S corporations and C corporations into one section. These companies are a better choice for you because they don't make you personally liable for the business's debts. They are more difficult to set up, but they give you the most flexibility.
A C corporation is formed under the laws of the state in which it's formed in. In many cases, this is Delaware because they are known to have the most well-developed set of laws governing corporations in the US. These corporations are typically backed by venture capitalists.
An S corporation is also formed under state law, but they come with the added bonus of having more favorable tax options. The main restriction is that you can't have more than 100 shareholders at any one time.

An LLC is another company formed under state law. The easiest way to see this type of company is a hybrid of the limited partnership and the corporation. The only real advantage they have over C corporations is more favorable tax rules.
Limited Partnerships

A limited partnership is formed under state law and is most commonly used to hold an investment in real estate. They are the perfect investment option of choice. Private equity funds and hedge funds love them. These are great if you want to setup multiple companies, specifically if you are thinking about how to best reduce your tax bill.
Changing Your Business Type

Unfortunately, changing your type of business isn't easy. Sometimes it's nearly impossible to make a clear transition. And if you can it's incredibly costly and often not worth it. Successful companies rarely run into this problem because they plan ahead. They set up a corporation even if they have yet to grow from a tiny team of employees.
In some cases, companies have found making the transition so difficult that they've made another company, closed the old one, and carried the brand over. Again, this is perfectly valid, but it's time-consuming.
All these problems can be avoided by choosing the right business type in the first place. It's worth talking to a professional about this before you go start submitting any forms.

It's relatively easy to get started with all the business types listed in this guide. You can even employ a professional to handle all the forms, if you prefer. Make sure you spend a significant period of time thinking over the various options available to you. It's not something you can change easily.
With all this in mind, which business type seems like the most attractive proposition for you?

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