A CPA’s Guide for Entrepreneurs
Starting a new business is an exhilarating journey, but the path to success is paved with critical decisions. One of the first and most fundamental choices you’ll make is selecting the right legal structure for your company. This decision has a lasting impact on everything from your personal liability to your tax bill. As a CPA-led accounting firm with a deep understanding of the business landscapes in both California and New York, we at TYS are here to demystify the process.
In this two-part series, we’ll break down the most common business entities, providing the insights you need to make a confident choice. Let’s begin with the simplest forms: the Sole Proprietorship and the Partnership
The Sole Proprietorship: The Entrepreneur’s Starting Point
If you’re a one-person show, you might already be operating as a sole proprietorship without even realizing it. This is the default business structure for an individual who starts a business and doesn’t register as another entity.
The Upside:
- Effortless Setup: The beauty of a sole proprietorship lies in its simplicity. There are no formal actions you need to take to legally form one. Your business is you, and you are your business.
- Complete Autonomy: As the sole owner, you call all the shots. There are no partners or board members to consult, giving you ultimate control over your business’s direction.
- Simplified Taxes: Your business income and expenses are reported on your personal tax return (Schedule C of Form 1040). There’s no need to file a separate business tax return, which can save you time and accounting fees.
The Downside:
- Unlimited Personal Liability: This is the most significant risk associated with a sole proprietorship. Because there’s no legal separation between you and your business, your personal assets—your house, your car, your savings—are on the line if your business incurs debt or is sued. For industries with higher liability risks, like construction, this can be a precarious position.
Raising Capital can be a Challenge: Lenders and investors are often warier of sole proprietorships due to their lack of formal structure. This can make it more difficult to secure funding to grow your business.
The Partnership: Two Heads (and Bankrolls) Can Be Better Than One
A partnership is the go-to structure for two or more individuals who want to co-own a business. There are a few different types, but the most common is a General Partnership.
The Upside:
- Easy to Establish: Like a sole proprietorship, a partnership is relatively simple and inexpensive to set up. While not always legally required, we strongly advise creating a comprehensive partnership agreement. This document will be your roadmap, outlining each partner’s roles, responsibilities, and share of the profits and losses.
- Pooled Resources: A partnership allows you to combine the financial resources, skills, and industry knowledge of multiple individuals. This can give your business a competitive edge and a stronger foundation for growth.
The Downside:
- Unlimited Personal Liability (for General Partners): Similar to a sole proprietorship, general partners are personally liable for the business’s debts. What’s more, each partner can be held responsible for the actions of the other partners, a concept known as “joint and several liability.”
Potential for Disagreements: When you bring multiple personalities and opinions into the mix, disagreements are bound to happen. Without a clear partnership agreement to guide you, these conflicts can escalate and potentially harm the business.
Is a Simpler Structure Right for You?
For low-risk businesses, freelancers, or those just testing the waters of entrepreneurship, a sole proprietorship or partnership can be an excellent starting point. The ease of setup and minimal administrative burden allow you to focus on what you do best: building your business.
However, as your business grows and your personal assets increase, the lack of liability protection can become a significant concern. In our next installment, we’ll explore the more formal structures that can shield your personal wealth from business risks: the LLC, the S Corporation, and the C Corporation.
Stay tuned for Part 2, where we’ll help you determine when it’s time to graduate to a more robust business structure.
Have questions – reach out to us