What is the legal structure of a business? Why is it important?

Business is not just about the right product/service and marketing. 20% of startups fail due to sub-par legal and financial structuring. It is a key aspect of proper functioning and making profits. 

So let us get into the basics of where everyone should start – Legal Structure of a Business. 

What is the Legal Structure of a Business?

Legal structure of a business is the organization’s ownership, liability and taxation structure in the jurisdiction where the company is formed. 

The business structure is of two types – formal and informal which are then classified into many. Choosing the right business structure will avoid a lot of business hurdles and enable quick growth and lesser tax, if optimized financially also. 

Importance of choosing the right business structure

Adds credibility to the company

Be it an idea or a fully developed product that you are pitching to your audience and investors, having a brand name and having it incorporated will increase credibility multifold. 

Especially formal business structures (corporation and LLC) have a higher value in the eyes of an onlooker compared to any informal business structure (Proprietorship and partnership). It will also mean you have put in the time and effort to form a business and other businesses will be willing to collaborate and transact with business rather than a person. 

Defines the operational and functional structure 

Operational structure of a business is a whole nother topic. The legal structure of a business paves way to a defined functional structure and hierarchy within the organization. 

As much as legal structure’s impact on the business, is the impact of functional organizational structure. It is usually structured based on roles, skills or projects to enable efficient working. The top level of the organization structure is where the business structuring has the most impact as it determines the ownership model and who controls the business. For example, LLCs need to elect a member to run the business. 

Defines and limits liability

Liability of the owners extends to their personal assets in an informal business structure whereas formal business structure protects its members and shareholders with limited liabilities. 

Choosing the right legal structure can save personal assets and even the managing personnel in case of business wind up, bankruptcy and claims. 

Enables tax planning and savings

Taxation is of two types – Pass-through where the profits from the business is taxed only in the owner’s income tax filing and the Corporate tax structure where the business pays corporate tax on profits and the owners pay tax on their cut leading to double taxation. 

Planning your business operation and cash flow ahead of time and choosing the suitable business structure will help save a lot in taxes. The options to diversify the income also is related to the legal structure you choose for your business. 

Fundraising methods 

Fundraising is an inevitable part if you want rapid expansion and growth. The legal structure defines the flexibility of the business to raise capital, offer stake/share, go public, etc. Only formal structure allows for easy fundraising and stake offering in the business. 

Securing the business name and trademark

Formal business structures require to have a unique name to differentiate from the rest. On the other hand sole proprietorship and partnerships are allowed to have redundant names. Though it has a lot of paperwork to do, formal business structures are the safest for branding and growth. 

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