As of February 2021, the most well funded tech startups in the United States (US) had received 15 billion US dollars, 3.4 billion US dollars and just under 3 billion US dollars respectively. It is clear that there is money to be made as a startup in the US.
Before attracting investors, prospective business owners will need to decide what type of structure their startup will have, i.e. which business entity will be the most beneficial for their startup. According to the US Small Business Administration, the type of business structure chosen will impact day to day operations, tax and risk to owners’ personal assets.
Sole Proprietorship
There are no formalities required in starting a sole proprietorship. The business comes into existence as soon as it starts operating. There is no separation between the business owner’s personal and business assets as the owner is the business. This increases risk to the owner but allows the owner to retain full control. While it can be difficult to obtain funding as a sole proprietor, this type of business entity is a good way to test a business idea before incorporating formally.
Partnership
Partnerships allow two or more people to own a business together and are often used by professionals such as attorneys, or as a way to test a business idea before incorporating formally. Types of partnerships include limited partnerships (LPs) and limited liability partnerships (LLPs). A limited partnership has general partners and limited partners. The general partners have unlimited liability to their personal assets but more control over the business operations. Limited partners have limited liability but less control over the business. In an LLP every partner has limited liability as they are not responsible for the actions of other partners.
Corporations offer the best liability protection but also the highest number of formalities, making them more expensive to run. The corporation as an entity is separate from its owners, the shareholders, which allows continuity in the event of ownership change and allows corporations to increase investment through issuing stock.
A specific type of corporation open to certified professionals is the professional corporation (PC), a type of corporation intended only for professionals in certain fields, such as attorneys, accountants, engineers and more. A PC has more limited asset protection than traditional corporations. Should several licensed individuals want to start a business, they could form a partnership, however, a PC offers more protection than a general partnership.
Traditional Corporation Versus Professional Corporatio
Similarities
Both types of corporations must write bylaws, hold shareholder meetings and pay corporate income tax. There is no recourse against the shareholders of either type of corporation in the event that the business goes into debt.
Differences
The main difference between these corporations is what happens in the event of malpractice. Only shareholders in a professional corporation can be used for malpractice. The shareholders can be sued individually and are only liable for their own mistakes, and not those of the fellow shareholders. Malpractice liability helps ensure that shareholders comply with the standards applicable to their industry.
Setting up a Professional Corporation
Each state has their own requirements for setting up a PC, and some require a PC for certain types of professions, such as attorneys and doctors. Before incorporating, each professional involved will need to have the relevant licenses. The same filings required of traditional corporations, such as the articles of incorporation and corporate bylaws, must be filed with the state. As a PC, these documents may need to be approved by the state licensing board prior to being submitted to the state. Since incorporation can be quite complicated, it may be simpler and more beneficial to appoint an incorporation service such as MyCorporation to incorporate the PC.
Prospective business owners can and should read more about how to start a corporation and professional corporation.
Limited Liability Company (LLC)
An LLC combines the best features of partnerships and corporations. It provides liability protection to owners, or members, by ensuring separation of business and personal assets but has more formalities than the corporation.
Final Thoughts
There are a plethora of startups in the US alone every year. Within these startups are sole proprietorships, partnerships, corporations (including professional corporations) and LLCs. Which entity is the most beneficial for a specific startup will depend on the nature of the business, who the business owners are, and what their priorities are; tax, ownership control, asset protection etc. Taking all of these into account, each prospective business owner can determine the most beneficial business entity for their startup.
