Understanding Small Business Structure and Insurance Needs

Understanding Small Business Structure

When an entrepreneur decides to start their own company, one of the first – and most significant—decisions they have to make is choosing a business structure.

Before getting your company off the ground, you may have to register your business to make it an official and distinct business entity, but the registration requirements vary based on your location and which business structure you choose. Moreover, the model you choose will affect how you pay your taxes and to what extent you’re liable for claims made against your business.

The most common business structures are sole proprietorships, partnerships, corporations, and limited liability companies (LLCs).

You should research each model’s pros and cons and choose carefully, as the wrong decision can result in tax consequences and further complications. Lawyers and accountants can help you with this decision, but here are the basics of what you need to know about each business structure.

Sole Proprietorship

According to the Small Business Administration (SBA), sole proprietorships are the simplest and most popular structure for starting a business. A sole proprietorship is a small company formed by an individual who chooses to start an unincorporated business, paying personal income tax on the company’s profits.

Sole proprietorships don’t have a separate commercial entity, so if you choose this business structure, your company’s assets and liabilities will not be separated from your personal ones. That is, you will be personally responsible for your company’s financial debts and obligations.

Partnership

If your business has more than one owner, partnerships are the simplest structure. There are two types: limited partnerships (LPs) and limited liability partnerships (LLP).

With limited partnerships, one partner, called the general partner, has more management responsibilities and takes on unlimited liability for the company’s debts. The other partner or partners have limited liability based on their financial investment in the business. In a limited liability partnership, there is no general partner, and all partners have limited personal liability.

Partnerships are a good option for professional groups working together or entrepreneurs who want to test a business idea. But be very careful when making partnerships: a long friendship or a handshake isn’t enough; you need to have everything in writing in case of disputes or lawsuits between the partners in the future.

Limited Liability Company (LLC)

Opening an LLC allows you to enjoy the best of all worlds: you have the benefits of corporations, sole proprietorships, and partnerships in the same legal entity, plus it comes with certain tax advantages. However, it’s important to note that LLC regulations vary from state to state, so you’ll need to research the specific laws in your jurisdiction.

The most significant benefit of forming an LLC is that owner or owners have limited liability. Since you are not personally responsible for company-related debts or lawsuits, most legal action against the LLC won’t affect your assets. Therefore, your home, car, and bank accounts will not be at risk if your company goes bankrupt or gets sued for most reasons.

S Corporation

The most complex organizational structure for a business is the corporation. While there are other types of corporations, S corporations (also called S corps) are the most common for new, smaller businesses.

S corps are designed to avoid double taxation. As explained by Business News Daily: “A business that files as an S-corp isn’t taxed by the federal government. Instead, as with a limited liability company (LLC) or partnership, shareholders pay individual income taxes on any profits they receive that have “passed through” the business…That profit is taxed at a lower rate than regular income, making it more advantageous to each owner.”

Also, each owner of an S corporation is protected with limited liability.

Various Forms of Liability Insurance for Businesses

Each business structure has its risks. That’s why it is important to protect your business—which may mean yourself—with different types of small business insurance, especially forms of liability coverage. Here are the most common liability policies to consider:

  • Commercial Auto Insurance –  A commercial auto insurance plan protects you and your employees in the event of vehicular accidents with company-owned vehicles. Policies that include liability coverage can pay for medical expenses and property damage expenses for other parties involved in an accident.
  • Commercial General Liability Insurance – This form of insurance covers third-party injuries, third-party property damage, and advertising injuries caused by your business or covered employees.
  • Professional Liability Insurance – Also called errors and omissions insurance, professional liability insurance covers claims of negligence, inaccurate advice, misrepresentation, and malpractice.
  • Cyber Liability Insurance – If a customer, client, or partnering business sue your company because of a cybersecurity breach, cyber liability insurance can cover the related legal expenses.
  • Product Liability Insurance – As the name suggests, product liability insurance protects your company from claims of damages or injury caused by a product you sold.

An Important Choice

The business structure you choose not only dictates how your company is taxed; it also determines your liability level as a business owner. If not weighed carefully, this decision can come back to haunt you in the case of a major lawsuit or economic downturn. To protect your company and your assets, be sure to do your due diligence when researching your options and making your final decision. And, whatever business structure you choose, be sure to purchase the right insurance coverage for the unique risks and liabilities associated with your industry.

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