Understanding business formation types is particularly important when opening your own company. You will have many decisions to make when you start your own business, including who to hire, where you want your office to be, how to market your product/service to customers, and how much to price it for. One of the most commonly overlooked aspects of starting your own company, however, is protecting yourself.

There are risks you take when you start your own company. Many of these risks can be avoided, or in the least, minimized. The smartest move you can make is to understand various business formation types; this will help you pick a type that is best suited for you and your company. More so, to pick a type that provides optimal protection.

What Types of Businesses Formation Are There?

You will have four basic business types to choose from:

  • Limited liability company
  • Sole proprietorship
  • Partnership
  • Corporation

What Is a Sole Proprietorship?

With a sole proprietorship, you have no protection, but it is an incredibly simple type of business to set up. It is especially ideal for those who run small businesses. You don't even have to file any papers. All you do is start operating your business and you're good to go. If you have minimal exposure, this type of business will be a good fit.

It's imperative to understand, however, that if you were to get sued, your personal assets may be at risk. This includes everything from your home to your car to your banking accounts. This is why you should consider other business formation types. If you want to operate your own company but want to do it under a name other than your legal name, you will need to file for a DBA, which stands for doing business as.

The process is quick and easy to file for a DBA. All you need to do is provide your legal name, the name you want the business to go by, your business address, and then pay a fee, which tends to be very small. Once you have acquired a DBA, you can then open a bank account under the new name for your business.

Being a sole proprietor means that you are the only owner of your company. You will have to report your income on your personal taxes with a Schedule C. Depending on how you conduct business, you may receive a 1099 form; this typically applies to freelance contractors who work on a freelance basis for companies rather than becoming one of their actual employees.

What Is a General Partnership?

A general partnership is another type of business formation that does not require you to fill out any paperwork. It is advised, however, to create a partnership agreement with whoever it is that you are going into business with. Just the same as a sole proprietorship, when you form a general partnership, you will not be provided any type of protection over your personal assets.

This type of business formation type can be incredibly risky. For example, if Partner A takes out a loan under the business' name and does not pay it back, then Partner B will be responsible. Any income and expenses that are incurred by the partnership have to reported on the partners' income tax returns.

What Is a Limited Liability Partnership?

A limited liability partnership can be formed when at least one person is willing to be the general partner while another person is going to be a limited partner. You will need to file paperwork to form this type of partnership.

Generally, a limited liability partnership is a good business formation type when a person wants to be a silent partner in a company. The general partner will spend his time conducting the business and making sure everything is flowing smoothly. The silent partner will likely be someone who is invested in the company only in a financial manner.

The person who is the limited partner is not going to be involved in the daily management of the company. Nor is he going to be personally liable for any of the debts that the partnership accrues.

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