Starting a contracting company is an exciting venture, but before you can start selling any services – determining your business legal structure comes first. This will determine how you operate your business, your tax obligations, and your liability. 

There are several main structures to choose from – sole proprietorship, partnership, corporation, and limited liability company (LLC). Each is distinct, with its benefits and drawbacks, and picking the right one is crucial to moving forward. We’ll explore each of these business legal structures to help you determine which one is right for your brand-new trade business.

Sole Proprietorship Legal Structure

A sole proprietorship is the simplest and most common business legal structure, ideal for small trade businesses with only one owner. As a sole proprietor, you are the business – personally responsible for all debts and liabilities.

Pros:

1. Simple & Inexpensive: A sole proprietorship is the simplest and least expensive business structure to form. In most cases, all you need to do is register your business with the state and obtain any necessary permits and licenses.

1. Complete Control: You’re truly the boss. You maintain complete control over your business and get to make all the decisions without having to answer to anyone else in the company. You do, however, still have to answer to your customers.

1. Easy Tax Filing: Taxes are made relatively simple. Report your business income and expenses on your personal tax return, and you don’t have to file a separate tax return for the business.

1. No Separate Legal Entity: Because a sole proprietorship is not a separate legal entity from its owner, there are no separate legal requirements, formalities, or compliance regulations involved.

Cons:

1. Unlimited Personal Liability: The biggest drawback of a sole proprietorship is that the owner has “unlimited personal liability” for the debts and liabilities of the business. This means that personal assets, such as a home or car, can be seized to satisfy business debts. There isn’t really much of a safety net – be advised!

1. Limited Ability to Raise Capital: It can be difficult for a sole proprietor to raise capital. Banks and investors are often hesitant to lend money or invest in a business that is owned by a single individual.

1. Limited Lifespan: A sole proprietorship can dissolve if the owner dies or becomes incapacitated, “knock on wood”. This is very bad if the business relies heavily on the owner. Also, sole proprietorships often change legal structures once the company grows or adds members. 

1. Limited Growth Potential: A sole proprietorship may not be the best business structure for companies that are looking to expand and grow. It can be difficult to take on new partners or investors, and there may be limits on how much revenue the business can generate.

Partnership Legal Structure

A partnership might be the right structure for you if you are starting a trade business with a friend. In a partnership, two or more people share ownership, profits, and business losses. Because a partnership is not a “separate legal entity,” each partner is also personally responsible for the debts and liabilities of the business. Partnerships can be general or limited, but those differences aren’t discussed here.

Pros:

1. Shared Responsibility: Inherent to a partnership is shared responsibility and decision-making, which can be hugely beneficial when starting a business. Each partner brings their unique skills and expertise to the table and helps disperse the workload.

1. Shared Capital & Resources: In a partnership, each partner contributes to the capital and resources of the business, which can help with startup costs and ongoing expenses. This shared investment can help a business grow and thrive.

1. Flexible Management Structure: Each partner can take on different roles and responsibilities based on their strengths and expertise. Partnerships allow much-needed flexibility for management logistics, which is particularly beneficial for businesses with multiple partners. 

Cons:

1. Shared Liability: Partners share personal liability for debts and obligations of the business. This means each partner is responsible for the actions of the other partners, which can be a significant risk.

1. Potential for Disagreements: Disagreements between partners will eventually happen, and if they can’t be resolved, it can lead to dissolving the partnership. This is the worst-case scenario, but it’s crucial to have a clear agreement in place that outlines how decisions will be made and how conflicts will be resolved to avoid this. Shared profits are a perceived benefit but can also be a challenge. Partners often have different expectations or disagreements about how profits should be distributed.

Corporation 

A corporation is a separate legal entity from its owners and can be owned by many as shareholders. This structure offers the most protection for personal assets and limits the liability of the owners. Corporations can also raise capital through the sale of stocks, making it a popular choice for larger trade businesses. They can be either a C or S corporation, but the differences aren’t discussed here.

Pros:

1. Limited Personal Liability: Likely, the most important advantage of a corporation is that it provides limited personal liability protection to its owners (also known as shareholders). This means that the shareholders’ personal assets are protected from the debts and liabilities of the business. Hopefully, you’ll never have to worry about this – but you’ll be glad to have it when you do

1. Ability to Raise Capital: A corporation can issue stock and raise capital by selling shares to investors. This can be a major advantage for companies that need a significant amount of capital to grow and expand.

1. Separate Legal Entity: A corporation is a “separate legal entity” from its owners. This legal jargon means that the business can: enter into contracts, sue and be sued, and own assets in its own name.

1. Perpetual Existence: A corporation has “perpetual existence”, which means that it can continue to exist even if a shareholder dies or sells their shares. Corporations are considered a fairly stable structure because of this. In essence, “you can kill the businessman, but you can’t kill the business.” 

Cons:

1. Complex Management Structure: Corporations have a more complex management structure than others, which includes a board of directors, officers, and shareholders. This can be disadvantageous in that it generally takes longer for decisions to be made and with more discrepancies. 

1. Double Taxation: Corporations are subject to double taxation, meaning the corporation’s profits are taxed at the corporate level and then again when they are distributed as dividends to shareholders. Good thing nobody’s invented triple taxation – yet.

1. Formalities and Compliance: Subject to more formalities and compliance requirements than other business structures, including annual reports, holding regular shareholder meetings, and keeping detailed records for required periods of time.

1. Expensive to Form & Maintain: Forming a corporation can be relatively expensive and very time-consuming. Ongoing maintenance is often very costly as well.

Limited Liability Company (LLC) Legal Structure

An LLC is a hybrid structure that offers the liability protection of a corporation and the tax benefits of a partnership. LLCs are considered separate legal entities from the owners, and the owners are called members.

Pros:

1. Limited Personal Liability: Owners (also known as members) receive limited personal liability protection. This means that the member’s personal assets are protected from debts and liabilities of the business – one of the main advantages of an LLC. 

1. Tax Flexibility: LLCs have the flexibility to choose how they want to be taxed. It can be taxed as a sole proprietorship, partnership, S corporation, or C corporation, depending on what is best for the business and its members.

1. Simple Management Structure: Relatively simple compared to the other legal structures, members can choose to manage the LLC themselves or appoint a manager to oversee day-to-day operations.

1. Easy to Form & Maintain: LLCs are relatively easy to form and maintain. The process involves filing Articles of Organization with the state, and annual reporting requirements are typically minimal.

Cons:

1. Self-Employment Taxes: LLC members are subject to self-employment taxes on their share of the LLCs profits. This can result in a higher tax burden compared to other business structures.

1. Costly Formalities: Some states require LLCs to file annual reports and pay annual fees for registration and operation, which can be expensive.

1. Difficult to Raise Capital: An LLC is not a good structure for companies looking to raise capital through public or private stock. They are not capable of providing public or private offerings.

Choosing the Right Legal Structure for Your Trade Business 

When choosing a legal structure for your business, several major factors must be considered. Your personal liability, tax obligations, and business goals should all be taken into account.

If you are starting a small trade business and want to keep things simple, a sole proprietorship may be the right choice. If you have a partner and want to share ownership of the business, a partnership may be a good fit. A corporation may be the best choice if you want the most protection for your personal assets and plan to raise capital through stocks. And if you want the best of both worlds, an LLC may be the perfect structure for your trade business.

Conclusion 

Choosing the right business structure is a major decision for any business. Whether you choose a sole proprietorship, partnership, corporation, or LLC – remember to consult with a legal and financial professional to ensure that you’re making the best possible choice for your new business. By understanding the pros and cons of each structure and considering your personal risks and goals, you’ll be ready to make an informed decision to help your business succeed.