New Business Herald

Category: Small Business

Practical finance and operations guidance for founders and owners.

  • Choosing a Business Structure: Sole Proprietor, LLC, S-Corp or C-Corp

    Choosing a legal structure is among the first decisions a new business makes and one of the few that is genuinely difficult to unwind later. The choice determines personal liability exposure, how profits are taxed, what administrative burden the business carries, and whether outside investment is practical.

    This article describes the structures commonly used in the United States. Terminology and treatment differ substantially in other jurisdictions, and specific tax rates, thresholds and eligibility rules change. Treat what follows as a map of the trade-offs, not as current tax guidance.

    The two questions that drive the decision

    Structures differ along two axes that are worth separating in your mind, because they are frequently conflated.

    Liability. Is the business a separate legal person, such that its debts and legal obligations stop at the business rather than reaching the owner’s home and savings?

    Taxation. Is profit taxed once, on the owner’s personal return, or twice — once at the entity and again on distribution?

    These are largely independent. An LLC can be taxed several different ways without changing its liability protection at all, which is the source of most confusion in this area.

    Sole proprietorship

    The default when an individual begins trading without forming anything. No filing is required to create it, though local licences and registrations may still apply.

    Liability: none. There is no legal separation between owner and business. Business debts are personal debts, and a judgment against the business reaches personal assets.

    Tax: profit is reported on the owner’s personal return and subject to income tax plus self-employment tax covering Social Security and Medicare.

    Reasonable for: very low-risk activity, testing an idea, minimal revenue. The absence of liability protection makes it unsuitable for anything involving physical premises, employees, meaningful contracts or professional advice.

    General partnership

    The multi-owner default, formed automatically when two or more people carry on business together for profit — sometimes without either realising it.

    Liability: unlimited, and importantly joint and several. Each partner can be held responsible for the full extent of partnership obligations, including those incurred by another partner acting alone.

    Tax: the partnership files an information return; profit passes through to partners in agreed proportions and is taxed on their personal returns.

    The joint and several exposure makes general partnerships a poor default. Where partners want pass-through treatment, a multi-member LLC generally achieves it with liability protection attached.

    Limited liability company

    The LLC is a state-law entity providing corporate-style liability protection with substantial flexibility in tax treatment. It is the most common choice for small businesses, and generally for good reason.

    Liability: members are generally not personally liable for the LLC’s debts, provided the separation is genuinely maintained.

    Tax: by default a single-member LLC is disregarded and taxed like a sole proprietorship; a multi-member LLC is taxed as a partnership. In both cases the LLC may instead elect to be taxed as an S corporation or a C corporation. The liability protection is unaffected by the election.

    Administration: formation and annual state filings, an operating agreement, and separate finances. Lighter than a corporation in most states.

    The protection is not absolute. Courts can disregard the entity — “piercing the veil” — where owners commingle personal and business funds, fail to maintain records, or leave the business obviously undercapitalised. Lenders also routinely require personal guarantees from small business owners, which contractually reinstates personal liability for that specific debt.

    S corporation election

    S corporation is a tax election available to eligible LLCs and corporations, not a separate entity type.

    Its principal attraction concerns employment taxes. An owner-operator must be paid reasonable compensation as a salary, subject to employment taxes. Remaining profit may be distributed without incurring self-employment tax. Where profit substantially exceeds reasonable compensation for the work performed, this can produce meaningful savings.

    The qualifications matter as much as the benefit:

    • “Reasonable compensation” is a genuine legal requirement and an established audit focus. Paying an artificially low salary to convert wages into distributions is a recognised and challenged position.
    • Payroll must be operated properly, adding real administrative cost.
    • Eligibility is restricted — limits on the number and type of shareholders, and a single class of stock.
    • The single-class-of-stock rule makes S corporations largely incompatible with venture financing.

    The election becomes worth examining once profit is comfortably above what the owner would be paid to do the same job for someone else. Below that, administrative cost tends to consume the saving.

    C corporation

    The default corporate form, and a separate taxpaying entity.

    Tax: the corporation pays tax on its profit. Dividends are then taxed again on shareholders’ returns — the double taxation that makes C corporations unattractive for businesses distributing most of their earnings.

    Despite that, it is the standard structure for companies seeking institutional investment, for several reasons: it accommodates multiple share classes with different rights, which preferred equity requires; venture funds often cannot hold pass-through interests without adverse consequences for their own investors; equity compensation mechanics are well established; and qualified small business stock treatment, available only for certain C corporation shares, can offer significant benefits to founders and early investors who meet the conditions.

    Double taxation also bites less for a company reinvesting rather than distributing profit — which describes most venture-backed businesses.

    How to choose

    • Any real liability exposure — employees, premises, contracts, professional advice? Form an entity. This consideration outranks tax optimisation.
    • Intending to raise venture capital? A C corporation is the expected structure, and converting later is possible but costly and disruptive.
    • Profitable owner-operated business with profit well above a market salary? Model the S corporation election with an accountant, including payroll cost.
    • Small, low-risk, early? An LLC taxed by default is usually sufficient, and can elect S corporation treatment later as profit grows.
    • Multiple owners? Whatever the structure, the operating or shareholder agreement matters more than the entity type — how decisions are made, how someone exits, what happens on disagreement.

    What this article cannot do

    State law varies considerably, including on formation costs, franchise taxes and annual fees that can materially change the comparison. Federal tax rules change. Professional licensing rules restrict which structures some occupations may use. And the right answer depends on facts specific to a business — revenue, profit, ownership, risk profile and plans.

    An accountant and a lawyer, consulted once at formation, cost far less than restructuring later or discovering that liability protection was never actually in place.

    Related reading

    For managing the cash consequences whichever structure you choose, see cash flow management fundamentals.

    This article is general information and journalism, not legal, tax or accounting advice, and it does not create a professional relationship. Rules change and vary by jurisdiction. Consult qualified professionals before choosing or changing a business structure. See our Editorial Policy.

  • Cash Flow Management Fundamentals for Small Businesses

    Profitable businesses fail regularly, and the mechanism is nearly always the same: the money owed to them arrives more slowly than the money they owe. Profit is an accounting result measured over a period. Cash is a balance that must be positive every single day. A business can satisfy the first condition and be destroyed by the second.

    Why profit and cash diverge

    Under accrual accounting, revenue is recorded when earned, not when collected. Issue an invoice on thirty-day terms and the sale appears in this month’s profit — while the cash appears next month, or later.

    Meanwhile, several large cash outflows never appear as expenses at all. Inventory purchases convert cash into an asset. Equipment purchases are capitalised and expensed gradually as depreciation. Loan principal repayments reduce a liability; only the interest hits the income statement. Tax is paid on a schedule unrelated to when the profit was earned.

    The consequence is direct: a growing business consumes cash. Growth means buying more inventory and funding more receivables before collecting on any of it. The faster it grows, the more cash it absorbs — which is why rapid growth is a common cause of insolvency rather than a protection against it.

    The cash conversion cycle

    The cash conversion cycle measures how many days cash is tied up between paying suppliers and collecting from customers. It has three components.

    • Days sales outstanding (DSO) — average days from invoice to payment.
    • Days inventory outstanding (DIO) — average days stock is held before sale.
    • Days payable outstanding (DPO) — average days taken to pay suppliers.

    The cycle is DSO plus DIO minus DPO. A result of sixty days means the business funds sixty days of operations from its own resources before customer cash arrives.

    Every day removed from that cycle releases cash permanently. This is the highest-return improvement available to most small businesses, and it requires no additional sales.

    Some businesses run a negative cycle — collecting before paying suppliers. Subscription services billed annually in advance and retailers with fast stock turnover and long supplier terms are the common examples. A negative cycle means growth generates cash rather than consuming it, which is a structural advantage worth designing toward deliberately.

    The thirteen-week forecast

    The single most useful cash management tool is a rolling thirteen-week forecast: a week-by-week projection of cash in, cash out, and closing balance, extended by one week every week.

    Thirteen weeks is the conventional horizon because it is long enough to reveal a problem while there is still time to act, and short enough that estimates remain grounded in known commitments rather than speculation.

    Build it on timing, not averages. Weekly granularity matters because monthly totals conceal the problem: a month in which payroll and a quarterly tax payment fall in the same week can average out comfortably while the business runs out of money on a Tuesday.

    Include everything that moves cash: payroll and associated taxes, rent, loan repayments including principal, tax instalments, insurance renewals, subscriptions and any seasonal outlay. Forecast receipts by expected payment date, based on how each customer actually pays, not by invoice due date.

    A spreadsheet is sufficient. Consistency matters far more than sophistication.

    Getting paid faster

    Receivables are usually the largest controllable component of the cycle.

    • Invoice immediately. Delay between delivery and invoicing is pure self-inflicted DSO. Invoicing weekly rather than monthly can remove two weeks from the cycle at no cost.
    • Make terms explicit before work begins. Payment terms, accepted methods and late-payment consequences belong in the engagement agreement, not discovered in dispute.
    • Take deposits. For project work, staged payments — deposit, milestone, completion — transform the cash profile and reduce exposure to a single non-payer.
    • Chase systematically. A defined sequence — reminder before due, contact on day one overdue, escalation at defined intervals — collects substantially more than sporadic chasing, mostly because it signals that the business tracks payment closely.
    • Remove friction. Accept the payment methods customers prefer. Card fees are frequently cheaper than the financing cost of an extra three weeks of DSO.
    • Check credit on large accounts. A significant new customer is an extension of unsecured credit and warrants the same scrutiny a lender would apply.

    Managing outflows without damaging relationships

    Extending payables improves the cycle, and is easily overdone.

    Negotiate longer terms openly rather than simply paying late. Suppliers can often accommodate a request they have agreed to, and will not accommodate unilateral behaviour. Paying late without discussion damages supplier relationships, forfeits early-payment discounts and can result in supply being withdrawn at the worst moment.

    Assess early-payment discounts arithmetically. A discount for paying twenty days early can represent a very high annualised return on the cash used — frequently better than any alternative use of it. Conversely, when cash is scarce, forgoing the discount is a form of borrowing whose cost should be compared against the credit line.

    Match asset financing to asset life. Funding long-lived equipment from working capital drains the buffer that covers operations.

    The buffer

    A cash reserve is not idle capital. It is what allows a business to survive a late-paying major customer, a delayed contract or an unexpected repair without distress.

    How much depends on volatility: businesses with concentrated customers, seasonal revenue or long cycles need more. The practical way to size it is to model the specific failure that would hurt most — the largest customer paying sixty days late — and hold enough to absorb it.

    Arrange credit facilities before they are needed. Lenders assess businesses most favourably when they are not desperate, and a line arranged in good conditions is available in bad ones. An unused facility costs little; an unavailable one costs the business.

    Customer concentration

    A customer representing a large share of revenue is a cash flow risk regardless of how reliable they seem. Their payment behaviour, their internal reorganisations and their own solvency all become the supplier’s problem.

    Concentration also removes negotiating power over terms, which tends to lengthen DSO precisely where the exposure is largest.

    Early warning signs

    • DSO rising over consecutive months.
    • Increasing reliance on the credit line to cover payroll.
    • Inventory growing faster than sales.
    • Paying suppliers later without having negotiated it.
    • Tax liabilities accumulating unpaid.
    • Growth in revenue with no corresponding growth in the bank balance.

    Each of these is visible months before it becomes critical, and each is far cheaper to address early than late.

    Related reading

    For the same analysis applied to published company accounts, see reading a cash flow statement. For how business structure affects tax timing, see choosing a business structure.

    This article is general information and journalism, not financial, accounting or legal advice. Consult a qualified professional about your circumstances. See our Editorial Policy.