Choosing the Best Small Business Legal Structure for Long-Term Success

Author: Kim Preheim, Senior Advisor, Small Business Banking

Whether pursuing a market opportunity or a particular passion, Americans are taking on the role of small business owners at an increasing rate. Entrepreneurship fuels the economy through the introduction of new products and technologies¹ as well as through job creation. In fact, small businesses are responsible for 70% of new jobs created since 2019.  

With so much riding on the small business sector, it’s vital that entrepreneurs choose the correct business legal structure. Setting the business up appropriately is key to safeguarding personal assets, optimizing tax benefits and ultimately supporting greater long-term success.

From Personal Protection to Investor Appeal: Why Your Business Legal Structure Matters

Choosing the right business legal structure from the outset is critical because the business’ entity framework will establish how liability is managed. For instance, some legal structures can help shield personal assets from business debts and legal claims, providing a layer of protection for small business owners. In addition, the right legal structure can allow for certain deductions and other favorable tax treatments.

Beyond liability and tax implications, the legal structure determines how the business is managed. A well-chosen structure helps define clear roles and responsibilities within the organization. This clarity not only supports day-to-day operations but helps make the business more appealing to potential investors or partners, as well as financing opportunities.

Limited Liability Corporation (LLC)

An LLC is a common legal business structure that combines the liability protection of a corporation with the more favorable tax benefits and operating flexibility of a partnership. With most LLCs, the owners are heavily involved in the day-to-day operation of the business, but their personal assets are protected from the company’s debts and liabilities, unless there is a specific personal guarantee involved.

An LLC can simplify taxation for many business owners through a concept known as a pass through. With pass-through taxation, profits and losses from the company are passed over to the owners’ personal returns. This set up allows owners to avoid paying both business and personal taxes on profits, while simplifying filings.

A limited liability corporation may also opt to be treated as a partnership or as a sole proprietor for tax purposes, in some cases.

Partnership

In a partnership, two or more individuals come together to own and operate a business. In general, the partners are accountable for running the operation, sharing in the profits as well as the liabilities.

Variants of this structure also exist. For instance, under a limited partnership, one or more partners are responsible for managing the daily operation of the business, while limited partners contribute capital. Limited partners share in the profits, but their liability is limited to the amount of their investment.

A limited liability partnership, on the other hand, distributes liability more evenly while adding a degree of individual protection. Under this legal structure, each partner is responsible for his or her own actions, and the remaining partners are free from liability for any acts of negligence, misconduct, or malpractice.

Sole Proprietor

A sole proprietor entity is ideal for independent contractors or gig workers as the structure allows the individual to report business income on their personal tax return. Set up is straightforward and regulation is minimal, making it easy for individuals to get started.

However, a sole proprietor must also personally bear any debts or liabilities, both financial and legal, incurred by the business, factors that must be carefully considered when setting up as a sole proprietor.

Determining the Right Business Entity for You

When it comes to selecting a legal structure for your business, there is no one size fits all solution. It’s important to carefully research each type of business legal structure and weigh the pros and cons against your way of doing business.

This is where advice from your support team, such as your legal and financial advisors, is critical. Your legal team can help you understand your business liabilities and where you will find the most adequate level of liability protection, and your accountant can add a taxation perspective. Your banker cannot provide legal advice, but can help you analyze and understand cash flow projections, funding needs and growth strategies.

Once you understand which structure provides the greatest advantages, including the opportunity for future loans and funding, you can decide how to set up your business.

Choosing the right legal structure is just the beginning of your business journey. At FNBO, we’re here to help you navigate the financial side of entrepreneurship, whether you need a business checking account, financing solutions or treasury management services to optimize cash flow.

Ready to take the next step? Learn about FNBO’s services and let’s grow your business together.

About the Author

Kim believes that small businesses are the life blood of the local economy, making him a perfect match for his role as a Senior Advisor of Small Business Banking at FNBO. In his position, he provides deposit and lending products to help fuel individual business growth, but his approach is far more personal. With each and every customer, Kim seeks to build long-term relationships that help him to proactively serve individual needs.