Being a TECH startup in the US means that you have a host of business opportunities available to you which is of course a good thing when you want to be on the cutting edge of technological developments but it might be frustrating when you are trying to find the most suitable business structure for your startup.
TECH startups vary depending on the products and services they offer. There are startups that are actually bringing a new technology product or service to the market which might need minimal costs especially if the product is purely digital or they might require substantial funding in order to move forward and achieve the highly coveted unicorn business status.
Other Tech startups might be differentiating existing tech products in the market or might be using technology to deliver their products and services or have a middleman approach to business such as Airbnb, Uber, Lyft etc. These are platforms that do not actually offer the service themselves and do not have very high operating costs but operate in a highly competitive environment.
There are different types of business entities in the US that can match your particular business needs i.e, if you are just starting out or if you are more well established in the industry, if you have particular tax demands etc. Also you can always transition from one type of business entity to another whenever you want depending on your business growth and the benefits you deem you will be getting out of the transition.
Below we attempt to showcase the most common business structures for tech startups so you can choose the one that best matches your current needs and will help you gain the most cost and tax benefits.
Informal Business Structures
Informal business structures generally are a good idea for businesses that are just starting out and are not at risk for liabilities. They also have a small customer base, don't expect to make a lot of money initially and want to keep management simple and low cost.
Sole Proprietorship and Partnership
Sole Proprietorships and Partnerships both have simple business structures and need minimal cost and effort to set up. The difference between the two is that a Sole Proprietorship has only one owner and a Partnership is made up of two or more owners / members.
Here are some of the advantages and disadvantages of these business structures.
They do not offer liability protection: they offer no protection to the owner(s) assets in the event of a lawsuit
They don't offer any tax benefits: the business's taxes are filed under the owner or owners personal tax return. There is no separation between the business and the owner.
They are simple to form and require minimal cost
They don't offer much credibility and branding opportunities as you need to use your surname(s) when opening a bank account, invoice, receive payments and in general market your business. This can be solved by filing for a DBA that will allow you to market your business under a different name than your own.
They are best suited for TECH startups that are at the very first stages of getting off the ground and maybe want to test out the market or you are thinking of turning a hobby / interest into a full time business. You should also make sure that your business is not high risk and profits are minimal as you will be starting out with a very small customer base.
Formal Business Structures
LLC and Corporation
On the other hand there are LLCs and Corporations that are formal business structures which means that they are more complex with complicated internal procedures and tax requirements that might be perfect if your TECH startup is looking to expand.
Advantages and disadvantages include the following:
Personal liability protection
Business growth potential is increased as formal business structures can obtain better loan agreements and attract venture capital.
Tax benefits: You can file your LLC under an S Corp tax classification in order to avoid paying self-employment taxes on your LLCs distributions.
Increased credibility. Your personal accounts and your business accounts are separate meaning that your business comes off as being more credible and well marketed helping attract potential customers as well as other businesses.
Formation and running costs are higher
More regulations your business needs to adhere to in order to enjoy the full benefits these structures have to offer.
LLC vs Sole Proprietorship
The main difference between a single member LLC and a Sole Proprietorship is limited liability protection. An LLC offers their owners asset protection from any debts or lawsuits which can come in handy if your business is more high risk. On the other hand an informal business structure such as a Sole Proprietorship does not offer any personal liability whatsoever.
However Sole Proprietorships offer simplicity and minimal costs which make them attractive if you have no prior business experience and are starting out slow. An LLC of course is not as complex as a Company to set up and run so it might be a good choice if you want to have liability protection and tax benefits.
You can read a more extensive guide on the advantages and disadvantages of sole proprietorship vs llc business formations on the TRUiC website if you need more info and guidance on choosing the right structure for your TECH startup.