Getting a franchise is undoubtedly a serious business decision that requires careful planning. Plus, you need to understand the legal structure of your company when franchising a small business to excel throughout your industry. Aside from putting in significant capital, the time and effort you will put into your business franchise should not be put in vain.
One of the first things you must consider is the legal structure of your business franchise. After all, you must ensure that it fits your business needs and capacity.
Here is a quick review of the business’ legal structures.
• Sole Proprietorship – the easiest to form and offers total control over your business
• Partnership and Limited Partnership – owned by two or more persons, but only one part has unlimited liability; the rest have limited liability.
• Limited Liability Company (LLC) – the LLC business startup structure gets the benefit of both LLPs and corporations.
• S-Corporation – a single-person S-Corporation is designed to get specific tax revenue requirements
• C-Corporation – a legal entity that is entirely alien from the owner.
Still, how do you know if you are getting the proper business structure? Here are the five questions that you need to ask.
What Specific Structure Does The Franchisor Require?
If the franchisor has a required business legal structure, you must abide by the franchise agreement; otherwise, you are free to determine your own business structure. Aside from this, this is also the time when you need to discern which of these three structures you can manage.
How Much Protection Against Liability Do You Need?
If you are concerned about protecting your asset, both LLCs and S-Corporations are good options. In this case, a Limited Liability Company (LLC) protects you and other members’ personal assets from debts, losses, and court ruling because your business is considered separate.
The same goes with S-Corporation; only money invested in your franchise by your and other shareholders is at risk. On the other hand, a C-Corporation has a higher level of liability protection, which applies to directors, officers, shareholders, and employees.
To What Extent Does Each Structure Affect Your Taxes?
For LLCs, the franchise owner is taxed individually from the member’s personal income tax rate. For C-Corporations, the business profit is taxed twice, first from the business profit tax rate, second from when the dividends are distributed to the shareholders.
Moreover, business profit and loss statements are reported at the corporate entity level; therefore, the shareholders cannot deduct any losses in their personal income tax returns.
As for S-Corporations, the business owner can choose how he wants his franchise to be taxed, either like LLC or a C-Corporation. In contrast, a C-Corporation will need to pay corporate income tax on its income, while the shareholders pay personal income taxes from the dividends.
What Kind Of Requirements Do You Want To Provide?
The simplest structure with minor requirements is an LLC. In fact, LLCs have fewer requirements for paperwork formation and compliance compared to other structures.
As for S-Corporations and C-Corporations, you will need to follow the required external and internal corporate formalities such as writing by-laws, holding shareholders and directors meeting, filing annual reports, and submitting other requirements to the government.
Overall, among the three structures, C-Corporations receive more government oversight because of the complicated tax rules and advanced level of protection.
How Much Expansion Of Your Franchise Business Are You Anticipating?
It is crucial to anticipate the growth of business and plan for your business expansion needs. Therefore, you should prepare a business development strategy to reduce potential setbacks. Take note that if you opt for the LLC structure, you cannot sell shareholders’ stock because an LLC structure does not allow shareholders.
So, if you are expanding, you don’t have shareholders to generate funds, unlike an S-Corporation, which allows a limited number of shareholders. In this case, you can have up to 100 shareholders with an S-Corporation.
However, entities such as partnerships and corporations as investors are not permitted in S-Corporations. On the other hand, a C-Corporation structure allows you to have unlimited stockholders. Therefore, you can have more significant opportunities for income generation and growth with this legal structure.
In conclusion, before setting up your franchise, it’s best to answer the above questions. However, deciding on your franchise’s legal structure is not easy, as you need to consider many things before you can do so. For example, your legal structure impacts your liability, tax bill, administrative concerns, and your growth possibilities. So, if you are in doubt, it might be better to ask for advice from professionals to avoid regretting your decision later on. In this case, a legal professional can help guide you over everything you need to know, as well as help you with any paperwork that needs filing once you decide on a legal structure.