Understanding the Different Business Structures for a College Startup
December 30, 2020
Thanks to the continuous and rapid development of technology, business opportunities are now more widely available for lots of people, including students. Today many students are taking this a step further by creating their own startups, either on their own or with friends. And this is something that is being encouraged by higher education institutes with more than 1,500 universities offering some form of entrepreneurial resource. While most students will likely focus on the development and marketing of their product, another aspect they must pay attention to is finding the right business structure. To help out we will dive in and examine the four main types of business structures namely: sole proprietorship, partnership, limited liability company and corporations.
The simplest and most common form of business structure is a sole proprietorship. Not only is this business structure super easy to form, but it also requires a lot less paperwork compared to others, which makes it ideal for small student startups. Unlike partnerships and corporations, this legal structure doesn’t ask owners to file any articles of incorporation, exhibit, or annual reports.
In addition to this, a sole proprietorship also gives owners complete control over their entire business. What this means is that all earnings go straight to the owner and tax filing is a lot easier since the company is not considered its own entity. The only downside in this case, is that owners are also held completely liable over the financial obligations of the business.
Formed when two or more people decide to run a business together, partnerships can be thought of as a hybrid of sole proprietorship — only in this case, a certain number of owners share the business. This structure is also common for college startups, as many are set up by a group of friends. Each partner has an equal share in the net profits and losses of the business. Since partnerships work just like the first business structure we’ve mentioned, partners are also expected to pay the taxes of their business’ profits through their personal tax returns and self-employment taxes.
Partnerships can be formed in many different ways, but the best option would be to have a written agreement drawn up by a lawyer. According to the U.S. Small Business Administration, partnerships can come in two forms: limited partnerships (LP) and limited liability partnerships (LLP). In LP there is only one general partner that has unlimited liability and relatively more control. In LLP, everyone has limited liability and is therefore equally protected.
Limited Liability Company
For student startups that are larger or looking to scale and expand, a limited liability company (LLC) is the next option. An LLC is the perfect combination of the perks you’d get from a sole proprietorship and corporation. Every state has slightly different requirements and benefits that student startups can take advantage of. So for students forming an LLC in Kentucky they will be able to avoid double taxation. This is because the owners are only required to pay taxes on their LLC profits when they file their own personal tax return — just like a sole proprietorship.
In addition to this, LLCs are also capable of offering a solid delineation between an owner’s personal asset and debts and their business’ financial obligations and debts, much like a corporation. With student startups more likely to fold or run into operating issues, this protects the owners from facing personal bankruptcy in the event that their business fails or gets sued.
For student startups that have had some success and are generating revenue they may want to secure additional funding and protection by becoming a corporation. Becoming a C corporation will boost a student startups’ credibility as it will demonstrate that it is an established business. The startup will also be able to receive funding through stocks.
However, one of the biggest drawbacks of establishing a C corporation is that you will likely have to pay double taxation. The only way to avoid such a problem would be to choose a business friendly state to start the business in. For instance, students who are fortunate to study and establish a corporation in Washington can avoid double taxation since the state doesn’t have personal or corporate income tax. Apart from this, the state of Washington also has a pretty straightforward corporate tax structure, which can be of great help when managing your taxes.
Since double taxation is the biggest concern entrepreneurs have when building corporations, a special type of corporation called S corporation was introduced. Not all states tax S corporations in the same way, but in most cases, this business structure allows profits and some losses to be passed through to the owner’s personal income directly — without being subject to corporate tax rates. To be recognized as an S corporation, your business should first be a domestic corporation with no foreign investors, less than 100 business shareholders and only one class of stock. Most student startups that become a corporation will likely fall under this category.
For young and budding student entrepreneurs, finding the right business structure that will work best for the organization is of the utmost importance. This is because the structure will determine numerous business aspects such as its taxes and capital generation, as well as determining the future of the startup and how it is managed.
Featured Image: Evangeline Shaw, Unsplash.