You have a winning business idea and you can’t wait to get started. However, before writing your business plan, renting space, designing a logo and website, and putting out the Now Open sign, an all-important decision awaits. Namely, the legal structure your new business will take.

“We love the energy and ambition of entrepreneurs,” begins Shana Peterson-Sheptak, PNC Bank’s head of Business Banking. “Yet, in their rush to get a business off the ground, some don’t think through the most important decision of all-- their company’s structure.”

The structure you choose affects how you do business, how you pay taxes, and how you’re shielded from potential liability.

The most common structures are Sole Proprietorship or LLC. Both have pros and cons. But, first, the basics.

Why Does My Legal Structure Matter?

Your company’s legal structure, sometimes referred to as a business entity, determines how you’ll be classified, regulated, and taxed by the government. At the federal level, your legal structure determines how you’ll be taxed. On a state level, it also affects your overall liability.

What Are Key Differences?

When choosing a legal structure, the differences aren’t just legal in nature. Peterson-Sheptak, states that the choices between the two are often driven by what you intend the business to do.

“For many would-be entrepreneurs, a small business is never meant to be a full-time gig. If it’s just your side hustle for extra money, a sole proprietorship structure may prove a quick and easy choice. This is especially true if you just want to test out a business idea and not get too complex in terms of paperwork or taxes.”

However, if you are taking the plunge with employees, vendor contracts, rent, and a good deal more, Peterson-Sheptak offers that an LLC may prove a smart choice.

“The benefits of an LLC fall into two main buckets. First, there are decided tax benefits. The second is shielding your personal assets from liability, both in terms of taxes and risks.”

So that is the overview. Now let’s run down the differences in greater detail:

  • Ownership. A sole proprietorship means you alone are the owner. An LLC can have multiple owners sharing decision-making and profits.
  • Naming. A sole proprietorship is known by the owner’s name on all government paperwork and banking. For example, if Joe Smith uses that structure for his landscaping business, the business’ legal name will be known as ‘Joe Smith.’ If Joe chooses to go by a brand name as a sole proprietor, it must be as a DBA (Doing Business As) in all documentation. An example? “Joe Smith DBA Sunshine Landscaping.” Meanwhile, an LLC is simply known by whatever business name you choose.
  • Paperwork and registrations. Once you conduct business, regardless of how modest those efforts might be, you are automatically deemed a sole proprietorship. Depending on the state where you do business, an LLC requires the development of formal incorporation papers for governmental records, filing tax returns, paying annual franchise fees, and creating annual reports. Make certain you understand the requirements in your own state. However, with both structures, a business owner must obtain any needed business licenses or permits.
  • Taxes. When it comes to paying taxes, the income from a sole proprietorship goes directly to your personal tax returns, otherwise known as a pass-through. While a pass-through is the default tax status for an LLC, the entity can opt to file a separate corporate return.
  • Liability. As a sole proprietorship, you are directly and personally liable for any debts incurred by the business. This means that, if your business gets into trouble, your personal assets could be at risk. Unless owners personally guarantee debt held by an LLC, personal assets are generally insulated from liability in the event of default.
  • ·Borrowing money. If your business requires a business loan, it is typically easier for an LLC to take out a business loan due to the separation between business and personal finances. However, if you borrow as a sole proprietorship, any business loans are reported on your personal credit, which may complicate or prolong the borrowing process as lenders need to assess your personal credit history alongside your business needs.

As Peterson-Sheptak is quick to point out, every potential business has its own unique needs and requirements. That is why it’s critical to get professional advice based on your situation, as well as the legal requirements in your area.

“As a bank, we provide strong support to our small business clients,” Peterson-Sheptak continues, “But there is no substitute for the knowledge that a CPA or a tax professional provides. They absolutely should be part of your team from the beginning.”

Changing From One Structure To Another?

What if your company begins as a sole proprietorship, only to succeed beyond your wildest dreams?

While it is certainly a good problem to have, those additional layers of complexity that come with success may require a change of structure from a sole proprietorship to an LLC.

“If you grow as a sole proprietorship and expand your team or have substantial vendor relationships,” Peterson-Sheptak points out, “Things become far more complicated. Those demands could require an entirely new structure. This is an especially smart move if you need to buy property or rent space.”

However, making the change isn’t done overnight. Changing legal structure entails paperwork, including creating and filing incorporation papers, updating titles and documentation on banking accounts, or closing vendor accounts and reopening them under the new corporate structure. And things can prove even more complex if your business has existing merchant service or treasury management relationships.

Peterson-Sheptak concludes, “Before you land on a corporate structure, ask the question, ‘How big can my company ultimately become?’ That should be answered before even starting out. How you begin your company has a major effect on how your company ends up.”

More Than Banking. Wisdom.

Regardless of what structure you choose to pursue with your new company, you’ll still need a strong business banking relationship. One that is based on trust and keeping your goals top of mind.

“At PNC Bank, we refer to ourselves as ‘Brilliantly Boring,’” concludes Peterson-Sheptak. “The reason for that is simple. Our small business clients rely on us for far more than a place to keep their money. We offer a host of services and prudent advice, and we’re reliably there for clients. Often that entails referring clients to the resources they need. In the case of clients just starting out, it’s finding professionals in the community to help them get advice on the right structure for them.”

To learn more about the full range of services and knowledge your new business needs to succeed, start your journey here, and learn how PNC can be the best business partner you’ll ever have.