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An Overview of Legal Entity Forms for Small Business Owners - Part 3: Choosing the Right Entity Form for Your Small Business

Part 3. Choosing the Right Entity Form for Your Small Business

(This post is Part 3 of a 4-part series on legal entities. Read Part 1 or Part 2.)

In Indiana, as of late October 2018, there are 126,784 active corporations in Indiana, and 282,826 active LLCs. Of course, there is no way to determine how many of these would be considered “small businesses,” but the numbers reflect what this author has observed to be a growing preference by small business owners to form LLCs versus corporations.

While the LLC form works well for many small businesses, business owners should not be swept up in trends and discount the potential advantages that a corporation may provide for their situation. Depending upon the organization and the owner’s personal finances, there may be asset and tax advantages to either incorporation as a company, or organization as an LLC, and both forms should be considered.

Many times there is not a clear right or wrong answer when faced with the question of what form of business entity to choose. It is often a balancing act. The following are a few of the major factors that you will want to consider when trying to determine the best entity structure for your business:

1.     The number and identity of the company owners. How many owners will your company have? What is the relationship between the owners? Will the owners be involved in running the business on a daily basis? Is it likely that the business will grow and add owners in the future?

2.     The experience and abilities of the company owners. Are the owners experienced in running businesses? Will the owners be willing to learn about running the business or hire professionals to help?

3.     The nature of the business itself. What goods will the company sell? What services will it provide? What risks are inherent in the nature of the business itself? What kind of buildings, equipment, leases, contracts, suppliers or inventory will be needed?

4.     The financial conditions of the owners. For a small company, with one or two owners, it’s important for the owners to consider their own, personal financial situation. Will the owners benefit more tax-wise from the business being structure one way versus another? This consideration often requires the owners to obtain input from their personal tax advisers.

In this author’s view, factors that would tend to point towards forming a corporation include: (1) A single owner with limited experience running a business and unlikely to take on additional owners in the future; or (2) Two or more owners that desire certainty over flexibility.

There may be other factors specific to your business that would tip the scales towards one form or entity over another. Taking the time and effort to set the entity up will result in a clear management structure and more predictable income and tax effects.

Part 4 of this series, Meeting With an Attorney About Your Business.