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Determine the Legal Structure of Your Online Business

How to determine the legal structure of your online business in 2021

There are a few different legal structures to choose from for your online business, and each has its strengths and weaknesses.  The legal structure you choose depends on the nature of your online business, but the one you choose will impact how your business runs. Therefore, it’s essential to understand the benefits and pitfalls of each structure to decide which one is best.

Legal Business Structures for Online Businesses

Not all business structures are relevant to online business, so it’s important when doing your research to only look at those applicable to your type of business.

Determine the Legal Structure of Your Online Business

Sole Proprietorship

A sole proprietorship is by far the most popular business structure for online businesses.  The business is owned and operated by one individual responsible for all the finances involved in business operations. As a result, virtually no paperwork is involved in starting operations, and your income taxes remain relatively simple.  If your online business is a ‘side-hustle’ or hobby to make some extra cash, this is probably the best option.

The requirements for paperwork filing depend on where in the world you are conducting business.  Different countries and municipalities have different requirements, but sole proprietorships don’t generally have many documentation requirements.  This is because, as a sole proprietor, your business and personal finances are inextricably linked.  Your business is not a separate legal entity from you and is considered part of your person, at least in legal and financial terms.

The thing to take into consideration regarding sole proprietorship is the legal liability implication.  Because all your personal assets are linked to your business, you are personally responsible for any debts incurred or for any legal suits filed against your business.  On the flip side, creditors can go after your business for any personal obligations you have. So be aware that you are conducting all business operations in your personal name when signing contracts for your online business under this structure.

Benefits

  • No barriers to entry; you form your business simply by acting as your business
  • Little or no paperwork for business startup
  • Easy to start and easy to dissolve
  • Inexpensive
  • Retain control over all aspects of business
  • Keep all business profits in your personal name
  • Tax-deductible costs

Pitfalls

  • In legal terms, you and your business are considered one entity
  • Hard to expand or hire employees
  • No ability to open separate business bank accounts or obtain credit
  • No personal protection against liability lawsuits

Partnerships

Structuring your online business as a partnership can be a benefit if you are working with one or more partners.  A partnership structure is flexible as it allows you to assign different levels of responsibility and liability to different members.  This structure is best for business ventures where two or more individuals share the responsibility or for businesses with an investor. 

There are three different partnership structures:

  • General partnerships are similar to sole proprietorships, where you simply go into business with another person and split responsibility
  • Limited partnerships have one person responsible for daily business operations and a silent partner who invests in the business without taking an active role
  • Limited liability partnerships allow all partners to be involved in business operations.  This structure reduces the individual liability of each partner

General partnerships don’t require any paperwork other than what you decide to contract on with your partner. However, it is strongly recommended that you create a formal, signed contract agreement with members of your partnership if there is a disagreement about your business in the future.  Limited partnerships may require filing for a business certificate, but little else.  Limited liability partnerships have a certain amount of paperwork involved, and there will be some costs to file this paperwork.

Benefits

  • It can still be easy to start
  • Liability protection available
  • Inexpensive
  • Ability to pool resources, capital, and talent with others
  • Can choose to pay taxes on either your personal return or as a business entity

Pitfalls

  • You could be held liable for the actions of one of your partners
  • If one member leaves the business, it legally dissolves the entire partnership
  • LLPs are not available for eCommerce businesses
  • Business decisions must be agreed upon by all partners

Limited Liability Company (LLC)

More time and paperwork are involved in setting up an LLC, but it’s worth considering if you are serious about your online business.  This can be set up by an individual or partnership arrangement, but it protects your personal assets and sets your business up as a separate legal entity.

An LLC is a form of incorporation that allows you to maintain complete control of your brand while separating your personal and business assets.  There is less regulation than a formal corporation, so it’s like a mix of a partnership and a corporation.  You will require name searches and business registration forms, operating agreements, and any required business licenses.  The costs for paperwork filing are relatively low, and you can still choose to file your income on your personal tax return or a separate business return.  The liability is very low with an LLC business structure.

Benefits

  • Low personal liability
  • Less administrative responsibilities than a corporation
  • Flexible taxation options
  • No double-taxing of business profits
  • You own all rights to your business name
  • Credibility

Pitfalls

  • Must maintain financial statements
  • May require renewal fees
  • Harder to raise capital for a startup

Corporation

We won’t talk a lot about this business structure, as it is rare for an online or eCommerce business to choose formal incorporation.  It is, however, an available option.

There are significant costs involved in setting up a corporation as it has extensive legal requirements for paper filing.  Tax obligations of corporations are generally relatively high. There is double-taxing involved, meaning your business will be taxed on income, and you will be re-taxed on your personal income.  The upside for corporations is that there is zero personal liability. 

You most likely will need to hire a lawyer and an accountant to incorporate your business.  If you are running a substantial online business with significant income and traffic, a corporate structure may be necessary.

Benefits

  • Total liability protection
  • Creditor protection
  • Profit retention
  • Ability to create stock options
  • It doesn’t require dissolving if a partner leaves the business

Pitfalls

  • Expensive and complicated to set up
  • High tax rates compared to other business structures
  • Double taxation
  • Heavy reporting regulations to government organizations
  • Requires a lawyer to set up
Determine the Legal Structure of Your Online Business

FAQ

What Business Structure is Best for an Online Business?

Most online businesses will start as sole proprietorships or general partnerships.  This structure is easy to start with low startup costs. However, this doesn’t limit your business structure in the future, as you can always change the structure into one with less legal liability once you see growth. Examples of corporations that started as sole proprietorships are Marriott hotels, Walmart, and eBay.

Can an LLC Sell Products?

An LLC can offer services or sell products. For example, if you’re running an eCommerce business, the product you sell might determine whether to set your business up as a sole proprietorship or an LLC.  For example, if you sell shoes, you’re not likely to face many lawsuits over your shoe sales.  However, if you sell weight loss or health supplements, there is an increased likelihood of litigation, requiring you to have a different legal structure.

How Much Does It Cost to Trademark a Business Name?

When filing for a trademark on a federal level in the United States, you should expect to pay $250-$350 to apply.  If you are filing applications to trademark multiple classes of goods or services, you will have to file separate applications and pay different fees for each one.  The filing fees are not refunded if your application is denied.  There is also a $300-$400 fee to renew your trademark once the ten-year period has expired.

Recommendations for Help Setting Up Your Online Business

Zen Business

Zen Business offers filing and registration services to set up your online business as an LLC.  You select the services you need help with and deliver all the necessary documents to you.  They also make sure to maintain ongoing compliance with state regulations.

Inc File

Inc File can help you set up an LLC, corporation, or nonprofit organization. In addition, they offer free filing services and trademark and business name searches to free up time for you to work on your business.

Inc Authority

Like our other recommendations, Inc Authority can help you set up your new LLC. In addition, they provide you with digital copies of all the needed documents and even offer tax planning consultations to help you take advantage of savings opportunities.

Recommendations for Legal Advice

As an online business owner, you might be wondering about legal advice. If you are seeking legal advice, there are a few legal services you can try online, one of them being Rocket Lawyer.

Rocket Lawyer 

Rocket Lawyer offers small to medium-sized businesses access to customizable legal documents and attorneys. Since 2008, they’ve been making legal care services affordable and accessible. You can either purchase a one-time service or create an account for ongoing access to services. 

Pros 

  • They make it easy to connect to a legal adviser 
  • They have a simple and intuitive user interface 
  • They offer an easy way to cancel services 

Cons 

  • You’ll receive a different attorney from time to time, as they do not provide continuity in that sense 
  • They don’t remind you when your free trial has ended or when the bill payment is due 

Conclusion

When choosing your business structure, it’s essential to know the pros and cons of each.  If you are new to running an online business or just starting up, it is okay to start with one structure and change it later.  Important considerations in choosing your legal structure are the type of business you are conducting, how many people are involved in running the business, and what kind of liability protection you need.