What Type of Entity Should of Form for my Small Business?

This blog post seeks to answer general questions without specific reference to any individual client's or potential client's specific case. As such, this blog post is not and shall not be construed as legal advice to any specific client or potential client. If you have specific questions about your business law question, please feel free to contact an attorney of your own choosing whom you feel you can confidently trust.

The answer to this question, as you might imagine, is not straightforward and is going to be fact-dependent in every scenario. Tailoring the business form to its status quo operation is key to ensuring that unwanted surprises don't arise down the road, detracting the business owner from doing what they love, running their business. Generally speaking, a small business owner should consider the following before forming their business: 1) size, 2) scalability, 3) cash flow, 4) business location, 5) mission statement, 6) branding, and 7) type of entity. Obviously, there are other finer details like what type of interior design you want in your office and whether you want a matte finish or glossy finish on your business cards, but the focus is on these big seven, which will stand as the foundation of your business.

First, with respect to size, we are, after all, discussing the "small business," so how big can you get before you are no longer considered a small business? Legally speaking, a small business is not clearly defined along numerical lines but as follows: the "Small Business and Self-Employed Tax Center serves taxpayers who file Form 1040, Schedules C, E, F, or Form 2106, as well as small businesses with assets under $10 million." So the IRS defines you based on your filing status, either 1040 or 2106. Form 1040 C is allocated to those businesses operated as a "sole proprietorship," which requires no legal formation and offers no legal protection. Form 1040 E is designed for supplemental income or loss from rental properties, royalties, S-Corps, residual interests, estates, trusts, or partnerships. Form 1040 F is utilized for the profits and losses related to farming businesses. Finally, 2106 is used as an employee deductions form for ordinary and usual expenses incurred in the line of their work.

Scalability is a term thrown around in the business world quite often with very little deep thought about its meaning. It is a simple term with deep implications which, if not fully understood in the context of your business, could mean loss of goodwill and reputation in the industry. Scalability, generally speaking, just means your business's ability to grow with the demand for your service or product. Easy enough to define but more difficult to implement in practice for several reasons. First, resources are often a limiting factor, and businesses many times may be faced with high demand but, due to their current financial situation, are unable to hire more employees or are unable to train them adequately. Second, is bad planning at the early stages; for example, you create an LLC, which is great because it offers limited liability protection, but that is it, nothing more, nothing less. An LLC taxed as an S-Corporation may be a better option for those wishing to grow—additionally, adding software (payroll, accounting) is also well worth the money and will assist in growing your business with less of your time and effort. While not every small business needs to turn into Microsoft, small businesses shouldn't be afraid to grow and to further succeed for their families and employees.

Cash flow is certainly probably the very first thing that a small business owner considers when they are first starting their business. How are you going to bring money into your business to pay employees (if any, but at minimum yourself), pay bills as they come due, maintain office space, fleets, tools, and any other direct/incidental costs of operating your business, ensuring its consistent operation each and every day? You have to think about the sources of your revenue stream, whether those are individual private clients paying for your services, customers coming into your brick-and-mortar store (or online), or government contracts you have to negotiate to bring money into your business. Do you have sufficient cash flow, or insufficient cash flow? Do you have sufficient staff to meet service demands, or are you bloated? Is billing and/or payroll processed seamlessly, or is it a fire drill every month?

The location of a business can make a world of difference, but regardless of location, if you have a great service or product for the client or customer and sufficient marketing, then your business can succeed. Depending on your business, location may also be limited. For example, if you run a kayak rental business, you may be restricted to sites along lakes, rivers, or oceans for obvious reasons. On the other hand, if you're a professional, attorney, accountant, or physician, you may be able to locate nearly anywhere with a sufficient potential client base. Since this is your small business, it is important to pick a location that you are comfortable in and avoid picking a location that feels like a compromise.

Every good small business should have some vision or goal; it's the reason why you got into business and is often referred to as your business's mission statement. The mission statement does not need to be set in stone but should come from the heart and be genuine. The mission statement can be viewed as your business's pledge of allegiance. It guides you as the owner, as well as your employees, in executing the business's day-to-day operations. The mission statement of my business is short and sweet and was also the motto of my alma mater, Willamette University: "Non nobis solum nati sumus"—not unto ourselves alone are we born. It is a daily reminder of why I got into the practice of law, to help others to the best of my God-given ability.

While you could spend tens of thousands of dollars on branding, marketing, website design, etc., please don't let a lack of resources prevent you from opening your business. Some branding and marketing are required, obviously. At a minimum, this means you need to have business cards, business contact information (telephone, email), signage if you're in a physical location, and while not completely necessary, a website will increase your business exposure and really should be a priority. You need to be able to separate all your personal communications from your business, avoiding mingling the two, but nothing is perfect before it launches—recall Microsoft. If Bill Gates had waited until Microsoft was perfect, he would never have released that software program. It's the 80/20 rule; Bill succeeded because the vast majority of his profits came from the vital few (20%) who could afford to buy it despite its problems (government, big business, foreign government).

Types of legal entities can be broken up into 1) sole proprietorship, 2) partnership, 3) corporations, 4) limited liability companies, 5) limited liability partnerships, and 6) PLLCs and PLLPs. A sole proprietorship is what it sounds like: yourself as the sole individual involved in the business with no other partners or employees. A partnership simply means two or more individuals engaged in a business venture for profit. There is no filing requirement to obtain a sole proprietorship or partnership, and they are typically the default rules under statute if no form is stated in writing.

Corporations (S and C) together with LLCs, LLPs, and the professional characterization of those entities require some form of filing with the State Secretary of State's office in order to be considered by the State of Washington to be a legally cognizable entity with all rights and privileges under the law attached. There are various reasons to choose one entity over the other given the specific facts of your business; however, consulting the advice of an attorney is certainly a prudent discussion during the planning process to ensure the entity type fits the needs and goals of the business. For further discussion on this issue, please feel free to contact me at (509) 592-9183, and we can discuss the specific options that make sense to you.