7 Reasons Why Legal Structure Matters in Business
When you start a business, one of the most important decisions you have to make is what kind of legal structure you will adopt. The legal structure of your business affects how you pay taxes, how you raise funds, how you protect your assets, and how you manage your liabilities. In this article, we will explain what legal structure means, what are the main types of legal structures, and why they matter for your business success.
What is Legal Structure in Business?
Legal structure is the way a business is organized and registered with the government. It determines how the business is owned, controlled, and taxed. There are different types of legal structures, each with its own advantages and disadvantages. Some of the most common ones are:
– Sole proprietorship: This is the simplest and most common form of legal structure. It means that you are the only owner and operator of your business. You have full control over your business decisions, but you also have full responsibility for your business debts and liabilities. You pay taxes on your business income as part of your personal income tax return.
– Partnership: This is when two or more people agree to share the ownership and operation of a business. Partnerships can be general or limited. In a general partnership, all partners have equal rights and responsibilities in the business, and they share the profits and losses according to their agreement. In a limited partnership, there is at least one general partner who has unlimited liability for the business, and one or more limited partners who have limited liability and limited involvement in the business. Partnerships file a separate tax return, but the partners pay taxes on their share of the profits as part of their personal income tax return.
– Corporation: This is when a business is registered as a separate legal entity from its owners. A corporation has its own rights and obligations, and can own property, enter contracts, sue and be sued, and issue shares. The owners of a corporation are called shareholders, who elect a board of directors to oversee the management of the business. The board of directors hires officers, such as a CEO or a CFO, to run the day-to-day operations of the business. Corporations pay taxes on their profits at the corporate level, and shareholders pay taxes on their dividends at the personal level. This is called double taxation.
– Limited liability company (LLC): This is a hybrid form of legal structure that combines some features of a corporation and some features of a partnership. An LLC is registered as a separate legal entity from its owners, who are called members. Members can be individuals, corporations, or other LLCs. Members have limited liability for the debts and obligations of the LLC, but they also have flexibility in how they manage and operate the business. An LLC can choose to be taxed as a corporation or as a partnership, depending on its preferences.
Why Legal Structure Matters in Business?
Choosing the right legal structure for your business is crucial for several reasons:
– It affects your tax obligations: Different legal structures have different tax implications for your business. For example, if you choose to operate as a sole proprietorship or a partnership, you will pay taxes on your business income as part of your personal income tax return. This means that you will be subject to the same tax rates and deductions as any other individual taxpayer. However, if you choose to operate as a corporation or an LLC taxed as a corporation, you will pay taxes on your profits at the corporate level, which may be lower or higher than your personal tax rate. Additionally, you will pay taxes on your dividends at the personal level, which may result in double taxation.
– It affects your liability exposure: Different legal structures have different levels of protection for your personal assets from your business debts and liabilities. For example, if you choose to operate as a sole proprietorship or a general partnership, you will have unlimited liability for your business obligations. This means that if your business fails or faces a lawsuit, your personal assets, such as your home or car, may be seized to pay off your creditors. However, if you choose to operate as a corporation or an LLC, you will have limited liability for your business obligations. This means that only your business assets are at risk, and your personal assets are generally safe from creditors.
– It affects your funding options: Different legal structures have different options for raising capital for your business. For example, if you choose to operate as a sole proprietorship or a partnership, you will have to rely on your own savings, loans from friends and family, or bank loans to finance your business. However, if you choose to operate as a corporation or an LLC taxed as a corporation, you will have access to more sources of funding, such as issuing shares to investors or selling bonds to lenders.
– It affects your operational flexibility: Different legal structures have different degrees of flexibility in how you run your business. For example, if you choose to operate as a sole proprietorship or a partnership, you will have full control over your business decisions, but you will also have to deal with all the administrative and legal tasks involved in running a business. However, if you choose to operate as a corporation or an LLC, you will have to follow certain rules and regulations, such as holding annual meetings, filing annual reports, and keeping records of your transactions. However, you will also have the benefit of delegating some of the responsibilities to your board of directors, officers, or managers.
How to Choose the Best Legal Structure for Your Business?
There is no one-size-fits-all answer to what legal structure is best for your business. It depends on various factors, such as:
– The nature and size of your business: Some legal structures are more suitable for certain types of businesses than others. For example, if you are a freelancer or a consultant who works alone or with a few clients, you may prefer a sole proprietorship or an LLC taxed as a partnership, which are simple and inexpensive to set up and maintain. However, if you are a manufacturer or a retailer who has a large number of employees, customers, and suppliers, you may prefer a corporation or an LLC taxed as a corporation, which offer more protection and credibility for your business.
– The level of risk and liability involved in your business: Some legal structures offer more protection for your personal assets than others. For example, if you are in a high-risk industry, such as construction or health care, where you may face lawsuits or claims from customers, employees, or regulators, you may prefer a corporation or an LLC, which limit your liability exposure. However, if you are in a low-risk industry, such as writing or photography, where you have minimal liability exposure, you may prefer a sole proprietorship or a partnership, which are simpler and cheaper to operate.
– The tax implications for your business: Some legal structures offer more tax advantages than others. For example, if you expect to make a lot of profits and reinvest them in your business, you may prefer a corporation or an LLC taxed as a corporation, which allow you to defer some of your taxes until you distribute dividends. However, if you expect to make modest profits and withdraw them regularly for personal use, you may prefer a sole proprietorship or a partnership, which allow you to avoid double taxation.
– The future goals and plans for your business: Some legal structures offer more flexibility and opportunities for growth than others. For example, if you plan to expand your business nationally or internationally, or sell it to another entity in the future, you may prefer a corporation or an LLC taxed as a corporation, which make it easier to raise capital and transfer ownership. However, if you plan to keep your business small and local, or pass it on to your family members in the future, you may prefer a sole proprietorship or a partnership, which give you more control and continuity over your business.
The Bottom Line
Choosing the right legal structure for your business is one of the most important decisions you will make as an entrepreneur. It can have significant implications for your tax obligations, liability exposure, funding options, operational flexibility, and future goals. Therefore, it is advisable to consult with a lawyer and an accountant before making this decision. They can help you understand the pros and cons of each legal structure and guide you to the best option for your specific situation.
What is a legal structure in business?
A legal structure in business refers to the way a company is organised and recognised by the law. It affects how the business operates, pays taxes, raises funds, and protects its owners from liabilities. There are different types of legal structures that suit different business needs and goals.
The global demand for legal structure services
According to a report by Grand View Research, the global legal services market size was valued at USD 849.5 billion in 2020 and is expected to grow at a compound annual growth rate (CAGR) of 4.4% from 2021 to 2028. The report attributes the growth to factors such as increasing demand for litigation, corporate, tax, and labour-related legal services, as well as the adoption of digital technologies and artificial intelligence by law firms.
The report also segments the market by service type, firm size, provider type, and region. The service type segment includes corporate, litigation, real estate, labour/employment, tax, bankruptcy, intellectual property, and others. The firm size segment includes large firms, medium firms, and small firms. The provider type segment includes private practitioners, legal outsourcing companies, in-house counsel, and others. The region segment includes North America, Europe, Asia Pacific, Latin America, and Middle East and Africa.
Some of the key players in the global legal services market are Baker & McKenzie LLP, Clifford Chance LLP, DLA Piper LLP (US), Hogan Lovells International LLP, Jones Day, Kirkland & Ellis LLP, Latham & Watkins LLP, Linklaters LLP, Norton Rose Fulbright LLP, and Skadden Arps Slate Meagher & Flom LLP.
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https://www.grandviewresearch.com/industry-analysis/legal-services-market)
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