One of the first decisions you will need to make when opening a new business, including a franchise, is what type of business organization you would like to use. If you’re not sure what your options are, don’t worry! We’ve got you covered. Check out the different types of business entities (also called business structures) available to your franchise and learn which one will work best for you.
Understanding The Franchise Business Model
The first thing to understand when choosing a business organization type is that franchises operate under a different model from other businesses. The franchisor and franchisee form a mutually beneficial arrangement that helps each of them grow their business under the franchise system. Buying into a franchise offers you a business model with a proven system and known brand name, which can increase your chance of financial success and make the process of starting a business that much easier for a new entrepreneur. Plus, the franchisor provides you with valuable information and support that will help your business to succeed. Otherwise, a small business franchise is much like any other small business.
3 Forms of Business Organizations
Despite the differences in the franchise model, your options when it comes to types of business ownership are the same as if you were starting a completely new business. You are legally the business owner, and as such, you will need to choose a business structure for filing your taxes. The most common forms of business ownership are sole proprietorship, partnership, and corporation.
A sole proprietorship business is the simplest of the types of business organizations. To set up a proprietorship, you usually just need to file a DBA (doing business as name) with the county you are doing business in, and you may need to register with your state for a business license. The proprietorship form of business organizations is the least expensive structure to form and works well for a small business with only one owner. But it also provides the fewest tax benefits and no personal liability protection, so consider carefully before going this route for your franchise. Without liability protection, your personal assets could be at risk if your business owes a debt or has a claim made against it.
A partnership business is quite similar to a proprietorship, with the primary difference being that you form a business partnership agreement to own your franchise jointly with one or more partners. Like sole proprietorships, partnerships are limited on tax benefits and protection from liability. However, you have the option of forming a limited liability partnership. Under this type of business organization, you will still file your business’s taxes on your personal tax return, but your personal assets gain some protection from claims made against your business.
A corporation is the most complicated and expensive business structure you can form. However, when used correctly, running your business as a corporation can often help you save money on your taxes. The corporation will be set up as a completely separate entity from yourself, and it will have its own separate tax records. Note that you will still need to file a personal tax return, and you will be considered an employee of the corporation. You also have liability protection with a corporate entity structure, but you should be aware that you are still personally liable for any contracts you sign as a guarantor. This can include your franchise agreement as well as business loans you take out.
Breaking Down The Types Of Corporations
You actually have several different types of corporations to choose from if you go with that option. What we usually think of as a corporation is called a C corporation. A C corporation can have an unlimited number of stocks that divide up the ownership, either privately or publicly. However, if you want the benefits of corporate structure while avoiding the possibility of double taxation, you may be interested in an S corporation.
The S corporation is a popular choice for small businesses, like franchises, that wish to incorporate. The biggest catch is that an S corp can have no more than 100 shareholders. This isn’t typically a problem for franchisees, which makes S corporations a good option for tax breaks and limited liability. And yes, you can form a corporation with yourself as the sole shareholder.
The final form of corporation is a limited liability corporation, or LLC. An LLC structure allows you to pass through the company’s income to your personal tax return, just like a sole proprietorship or partnership. But unlike a proprietorship, a limited liability company allows liability protection similar to that of a corporation. It is a hybrid structure that allows protection without the risk of double taxation. And it works well for franchise businesses with only one or two owners.
Now that you have an overview of the forms of business organization, you should be able to narrow down your choices to the one or two that fit your franchise needs best. You may want to consult your accountant or legal advisor to ensure that you’ve considered all the pros and cons. Just be sure that you consider what will be best for your business in the long-run rather than going with what is cheapest or easiest now.