If you are thinking about starting a business, you are probably investigating corporate structure and how it can affect your business, from your taxes and liability to your company policies and finances. How you fund your business, and the amount of funding you can get, may have a direct impact on its financial viability. Therefore, you need to know how your structure can affect your finances.
Sole proprietors, LLCs and partners tend to have pass-through tax status. This means that these businesses do not pay taxes on their incomes. Instead, the owners pay taxes on their personal and business incomes. S-corporations are also taxed on a pass-through system, but their shareholders are taxed based on the dividends they receive while the rest of the income is passed through to the owners and taxed on their individual returns. This tax rate is lower than the corporate rate.
Corporate taxes are more challenging, and these business owners often pay double the tax. For example, they will have to pay their state and federal taxes on the business income. Then, if they received any dividends or distributions, they have to pay taxes on the distributions as well.
Sole proprietors may have difficulty gaining debt financing unless they have exceptional personal credit because the bank sees the owner and business as a single entity. Partners have greater flexibility when it comes to debt financing. Although the partners’ personal credit histories play a role, because the business is a separate entity, it can build credit as well. However, this debt is still tied to the owners, so they will be held responsible for any outstanding debt. LLCs have the same financing options, but they are protected from debt liability.
Because corporations are separate business entities, they have more debt financing opportunities, including corporate credit cards and loans, and this financing is based on the company’s credit, not the owners’ history.
Unlike sole proprietorships, partnerships are eligible for equity financing. Either the partners can invest more in the company and receive a larger percentage of the company, or new active or silent partners can join and gain equity partnership. Venture capital funds cannot typically invest in LLCs, but they may be eligible for equity financing by adding member investors.
Corporations have easy access to equity financing through selling stock in their companies. However, they are also eligible for angel or venture capital investors. This is especially valuable during the initial startup and growth phases.
Before you decide on your corporate structure, consider how it will affect your business’s finances.