For Your Business
Choosing a Business Structure
In March 2015, about 679,072 new business had been created in the preceding year.¹ All individuals pursuing the dream of exercising their entrepreneurial muscles, will face the same question, “Which business structure should I adopt?”
Each option presents its own set of pros and cons. This overview is not intended as tax or legal advice and may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding the most appropriate business structure for your organization.
Sole Proprietorship/Partnership
This structure is the simplest. But it creates no separation from its owner. Income from the business is simply added to the individual’s personal tax return.
Advantages: Easy to set up and simple to maintain.
Disadvantages: Owners are personally liable for the business’s financial obligations, exposing their personal assets (house, savings, etc.). It does not offer the prestige or sense of permanence of a corporation or LLC.
C-Corporation
A corporation is a separate legal entity from its owners, making it easier to raise money, issue stock, and transfer ownership. Its life is perpetual and will survive the owner’s death.
Advantages: There may be tax advantages, including more allowable business expenses. It protects owners from personal liability for the company’s financial obligations and may lend a measure of prestige and permanence.
Disadvantages: More expensive to set up, the paperwork and formality are greater than for a sole proprietorship or LLC. Income may be taxed twice, once at the corporate level and when distributed to owners as dividend income.
S-Corporation
After forming a corporation an owner may elect an “S-Corporation Status” by adopting a resolution to that effect and submitting Form 2553 to the IRS.
The S-corporation is taxed like a sole proprietorship, i.e., the company’s income will pass through to shareholders and be reported on their respective personal tax returns.
Advantages: S-corporations avoid the double taxation issue associated with C-corporations, while enjoying many of their tax advantages. Owners are shielded from personal liability for the company’s financial obligations. It provides the prestige of a corporation for small businesses.
Disadvantages: S-corporations do not have all the tax-deductible expenses of a C-corporation. The cost of set up, the paperwork, and formality are greater than for a sole proprietorship or LLC. S-corporations have certain restrictions, including a "100 or fewer" shareholders requirement. Shareholders must be U.S. citizens and the business cannot be owned by another business.
Limited Liability Company
An LLC is a hybrid between a corporation and a sole proprietorship, offering easy management, pass-through taxation, and the liability protection of a corporation. Similar to a corporation, it is a separate legal entity, but there is no stock.
Advantages: LLCs provide the protections of a corporation, but are taxed similar to a sole proprietorship.
Disadvantages: Typically more expensive to form than a sole proprietorship, LLCs require more paperwork and formalized behavior.
Remember, the choice of business structure is not an irreversible decision. You may amend your business structure to accommodate your changing needs and circumstances.
1. Bureau of Labor Statistics, 2016
What is the Value of Your Business?
In the first quarter of 2015, nearly 2,000 small businesses were sold. The median sale price was $200,000, up from $175,000 the year before.
As a business owner, ascertaining the value of your business is important for a variety of reasons, including business succession, estate tax estimates, or qualifying for a loan.
There are a number of valuation techniques, ranging from the simple to the very complex. Outlined below are three of the different approaches to valuing a business.
- Asset Based: Calculates the value of all tangible and intangible assets held by the business. This approach ignores the future earning potential of the company. Thus, a pure asset-based valuation model is often used for companies that are bankrupt or looking to liquidate.
- Earnings Based: Seeks to arrive at a business’s value by applying a multiple to normalized earnings, i.e., earnings adjusted to subtract owner’s compensation and related expenses. The multiplier can vary substantially, depending upon the industry and the outlook for the business.
- Market Based: Compares the business to recent sales of similar companies.
Business valuation is not just a formulaic exercise. For instance, there is a value to the business of being a “going concern” as opposed to the start-up alternative. Ownership percentage will also matter; purchasing a minority share that has limited control may result in a discount to the actual value. The prospects for the business impact value. A greater premium will likely apply to a company engaged in a leading-edge technology than to one involved in a mature market.
Valuing a small business is not an exact science. Some aspect of the valuation may be debatable (e.g., the remaining life expectancy of a machine), while other aspects may be positively subjective (e.g., the value of the company’s reputation).
Willing Seller & Buyer
The true value of anything can only be determined when a willing seller and a willing buyer agree on a price of exchange. As a consequence, any valuation exercise may yield only a rough estimate.
Before moving forward with a business valuation, consider working with legal and tax professionals who are familiar with the process. Also, a qualified business appraiser may be able to offer some valuable insight.
Succeeding at Business Succession
According to a recent study by U.S. Trust, 64% of millionaire business owners over 50 have no formal succession plan.¹ While the number may shock you, it is not surprising that many small business owners are consumed by the myriad responsibilities of running their businesses.
Nevertheless, owners ignore succession planning at their peril, and possibly at the peril of their heirs.
There are a number of reasons for business owners to consider a business succession plan sooner rather than later. Let's take a look at two of them.
The first reason is taxes. Upon the owner’s death, estate taxes may be due, and a proactive strategy may help to better manage them.² Failure to properly plan can also lead to a loss of control over the final disposition of the company.
Second, the absence of a succession plan may result in a decline in the value of the business in the event of the owner’s death or unexpected disability.
The process of business succession planning is comprised of three basic steps:
- Identify Your Goals: When you know your objectives, it becomes easier to develop a plan to pursue them. For instance, do you want future income from the business for you and your spouse? What level of involvement do you want in the business? Do you want to create a legacy for your family or a charity? What are the values that you want to ensure, perhaps as they relate to your employees or community?
- Determine Steps to Pursue Your Objectives: There are a number of tools to help you follow the goals you’ve identified. They may include buy/sell agreements, gifting shares, establishing a variety of trusts or even creating an employee stock ownership plan if your desire is that employees have an ownership stake in the future.
- Implement the Plan: The execution step converts ideas into action. Once it's implemented, you should revisit the plan regularly to make sure it remains relevant in the face of changing circumstances, such as divorce, changes in business profitability, or the death of a stakeholder.
Keep in mind that a fundamental prerequisite to business succession planning is valuing your business.
As you might imagine, business succession is a complicated exercise that involves a complex set of tax rules and regulations. Before moving forward with a succession plan, consider working with legal and tax professionals who are familiar with the process.
