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November 13, 2024
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Getting Started: Structuring Your Business for Long-Term Success

You’ve hung up your shingle and brought in your first client. Whether your business is landscape design, catering or computer consulting, you’ve now become a sole proprietor. It’s a very simple proposition that requires no extra paperwork and carries no upfront expenses. But it comes with some significant drawbacks once a business starts growing.

“Unfortunately, a lot of business owners are so intent on growing their business that they don’t do the long-term planning that they should,” says Richard Martin, director for the Center for Business Analysis at Massachusetts Mutual Life Insurance Company (MassMutual), headquartered in Springfield,

Massachusetts. Too often, he says, they overlook both the need for liability protection and the importance of business structure when it comes time to sell the company.

A sole proprietorship draws no distinctions between the business and the owner. Taxes from business income and expenses flow directly through to the individual. So does liability, exposing the sole proprietor’s personal assets to any lawsuits that may be filed. That means a business accident—damage done while catering an event, for example—can threaten not only the business but also the family bank account.

It’s important to select the business entity that offers the right degree protection without overcomplicating operations. Which entity a business owner chooses should depend on long-term business goals, tax considerations and likely exit strategy.

DiSH, a small retail food business that provides gourmet prepared meals for home consumption, operates as a limited liability company. Co-owner Stacey Quinn says she carefully reviewed the business’s structure last year before purchasing a 50% share of the Andover, Mass., company. While tax liabilities pass directly to the owners, both Quinn and her partner can shield their personal assets from potential claims against the business. And, says Quinn, if she and her partner ever decide to stop marketing meals, “we’d still have an entity to sell.”

Formation of an LLC requires drafting of an operating agreement and notification to the state. Yet it remains a relatively simple structure, which is exactly what the DiSH partners wanted. “It isn’t complicated, and it keeps our costs down in terms of accounting and record keeping,” says Quinn.

Becoming an S corporation adds a layer of complexity, since it requires a board of trustees, regular meetings and minutes. While S-corps are often taxed on a pass-through basis like a partnership, this business entity can offer a growing company some meaningful tax advantages. There are, for example, significant savings on payroll taxes, since Social Security and Medicare taxes are paid only on that portion of S-corp profits deemed to be wages. S-corps also have the ability to offer some limited employee benefits, such as retirement plans.

Companies looking to raise capital may want to consider the C corporation, a structure that allows for different categories of shareholder. It is favored by venture capitalists, who like to hold preferred stock. A C-corp can also provide key employees with attractive fringe benefits, ranging from retirement plans and health insurance to deferred compensation.

Many owners, however, don’t consider the ramifications of being a C-corp.. For example, C-corp profits are taxed twice—once at the corporate level and again when individual shareholders receive them as distributed dividends. This double taxation problem becomes even more significant when a business is sold, greatly reducing the after tax-proceeds of the transaction.

One answer to the problem might be to convert to an S-corp before selling. That approach, however, requires long-term planning, since such a conversion must be in effect for 10 years in order to get the full benefits of the favorable S-corp tax treatment..

By considering the advantages and disadvantages of different entities when setting up the business, owners can address tax considerations, liability concerns, shareholder needs and the eventual exit and succession of the business. The result: A lot of problems may be avoided. For more information call us at (201) 449-0026 or visit us at www.blsfinancial.com.

The information provided is not written or intended as specific tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. MassMutual, its employees and representatives are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel.

Provided by Jenna

Bienenfeld, a financial representative at Bienenfeld, Lasek & Starr, LLC; courtesy of Massachusetts Mutual Life Insurance Company (MassMutual)

 © Massachusetts Mutual Life Insurance Company, Springfield, MA 01111-0001

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