Published in The Tennessean July 27, 2015
By Ed Rappuhn – SCORE Nashville
“I’ve been running a business as a hobby and am ready to get serious. Do I need to form a company and what do I do?”
By running the business as a hobby, you’ve gained some valuable experience and that’s a great start. And yes, if you are serious about the business, it’s best to form a company. Start by naming your business and deciding on your legal structure. Here are your choices:
A sole proprietorship , the simplest entity, is used for a single owner. It is so simple, in fact, that if you might already be a sole proprietor if you are reporting business income and expenses on schedule C of your tax return. The downside is you have no protection from lawsuits against the business; your personal assets are in play.
A partnership is like a sole proprietorship except there are multiple owners, each with a specified percentage of the business. Profits and losses are passed through to the partners and again, personal assets are unprotected.
A Limited Liability Company (LLC) calls the owners “members” and can have one or more members. Profits and losses are passed through to members. An LLC has greater costs and legal requirements than the previous structures but its greatest benefit is that the members’ personal assets are shielded from lawsuits against the company. Realize, however, that members could be sued personally for their actions and you will almost always personally guarantee loans.
An S-Corporation is like an LLC except that the owners hold stock rather than “membership.” It is more formal than an LLC with more ongoing legal requirements. It provides similar protection for personal assets and profits are passed through to stockholders, but there are some differences in taxation. Some investors prefer an S-Corp because it is easier to later switch to a C-Corp.
A C-corporation , the most complex structure, offers the greatest ownership flexibility. But it can result in double taxation, at the corporate and personal levels, when profits are distributed; therefore, few startups choose this option.
Go to sba.gov for more details then discuss your options with your business advisor, lawyer, and accountant to choose the structure best for you.
After deciding on your structure, get an EIN (employer identification number) from the federal government. This is like a social security number for your business. Get business licenses if required by your city or county. Next set up a checking account in the business’ name and keep personal and business records separately. Draft a buy-sell agreement if you’re going to have a partner. Think of this as a prenuptial agreement for your business; it describes what happens should there ever be a breakup.
These are the basics for turning your hobby into a business. Good luck with your venture.
Ed Rappuhn is a mentor, workshop facilitator, and the past-chair of SCORE Nashville. SCORE mentors guide entrepreneurs in starting and growing their businesses. Sign up for a free SCORE mentor, find out about our reasonably priced workshops and other services, or volunteer to become a SCORE member at www.scorenashville.org .