August 3, 2013 9 comments

How to Choose Your Business Entity and Business Insurance

by Regina

Choose your business entity and your business insurance the right way!
Okay, so I had to update and republish this post from three years ago because . . . after sooooo many businesses and sooooo many mistakes, the information needed some changes and some worksheets to help you plan the right way.

Why? The business entity you choose, and the insurance you do or do not put in place can both quite literally make or break your business.

Your entity and your insurance can:

  • Protect you and your profits at tax time
  • Protect your business from having to fold from a frivolous lawsuit that happens to go through
  • Help people take you seriously
  • Make sure you are complying with local + national laws
  • Help ensure your employees are properly taken care of
  • Kick in when you can’t work (illness, injury, etc.) so that you still have funds to live off of
  • And so much more

Keep reading below for information on the types of business entities that are available to you (if you’re in the U.S.—if not, look for comparable entities in your area), and the types of insurance policies you can hold.

But first, grab these planning sheets below to help you take notes and stay on track with this guide!

Choose-Your-Business-Entity-and-Insurance-Worksheets


Business Entities

There are a number of business entity options for your company. Each type of organization presents benefits and drawbacks in cost, paperwork, ease of formation and management, owner liability and other legalities. Use the following information to match your business goals with the form of business that will work best for you. Don’t forget to research the entity in your state/area that you will fill out your business formation paperwork with so that you can record the current price and requirements.

Sole Proprietorship

A sole proprietorship exists when a single individual owns a business and all its assets, without establishing a legal separate entity. Whereas creating a corporation or LLC actually establishes a separate entity (those are explained below, by the way), in the eyes of the U.S. government, there is no distinction made between a sole proprietorship and its owner.

This means that you will claim all profits or losses on your personal income tax return (super easy to do), and it also means that you are liable for all business debts or claims against your business. In other words, no distinction is made between your personal and business financial obligations. An unhappy client, disgruntled subcontractor, or offended vendor can sue you for your personal property unless you are insured (which we talk about at the bottom of this guide).

You can operate your sole proprietorship under your legal name or under a business name that you create, often called a “fictitious name.” If you plan to name your company, you should fill out an “assumed name certificate” or “doing business as” certificate in the county in which you will operate your business. Sole proprietorships and general partnerships (described next) are the easiest and most inexpensive business entities because there are few legal restrictions. However, without insurance you could stand to lose a lot. This type of business is best if you are insured or are in a low-risk industry (i.e. you’re not likely to be sued).

Also note: A sole proprietorship has a limited life, meaning the business as an entity cannot be transferred to another owner. Since there is no distinction between you and your business, transferring your business to the ownership of another person would be like transferring yourself to the ownership of another person. Sounds ridiculous, right?

If you want to sell your sole prop business you could sell your assets, your intellectual property, your client accounts, and any trademarks you own, or you could form a legal separate entity (like an LLC, described below) and then sell that.

How/where to file: You can visit your local county clerk’s office or website for more information or to obtain the form you need to file your sole proprietorship name. This will usually be called an “assumed name” form, a “doing business as” or “DBA” certificate, or a “fictitious business name” filing. Whatever the form title, you will declare that you as an individual will operate a business under a certain name in the county in which you register it. The fee to register a business name in this manner can range from around $10 to $30 or more.

General Partnership

This is another unincorporated form of business and is similar to a sole proprietorship except that it must include two or more people. Each partners’ personal assets are still at risk if the company owes creditors or is involved in a lawsuit. If one partner signs a contract or enters into an agreement, the other partners are subject to that agreement.

The general partnership structure is recommended for individuals who have a long history together and have established trust. Otherwise, it may be a good idea to look to a limited liability company or corporation. In most states you can also form a limited liability partnership (LLP), which offers each partner more protection against the actions/decisions of other partners.

How/where to file: The paperwork to file for a general partnership is usually the same as a sole proprietorship (above), and can therefore usually be obtained at your county clerk’s office.

Limited Liability Company (LLC)

A limited liability company is a business type that forms a separate legal entity and provides limited liability to its members or managers. An LLC has less paperwork than traditional corporations, and its member(s) can enjoy not being double taxed (e.g., with certain corporations your business profits are taxed then the dividends paid to you as an owner are taxed). LLCs can have single owners or can be owned and operated by multiple entities.

An LLC is often considered the easiest form of an incorporated business to run. It offers many of the great characteristics of a sole proprietorship or partnership (no double taxation, fewer restrictions, easy to form and manage) plus some of the benefits of a traditional corporation (separation of business and personal assets, the business can be transferred to new owners, etc.).

LLCs are my favorite form of business to use for a creative business, coaching business, freelance business, or infopreneur business. Depending on the state you live in, you may have to file your forms only once, or you may have to “re-up” your LLC every few years.

How/where to file: To form an LLC you will file forms with your Secretary of State (in most states) or your state’s commerce division. You may also choose to use an attorney or other entity to help you file your paperwork. For example, a company like LegalZoom.com can file on your behalf.

Choose-Your-Business-Entity-Worksheet

Corporation

In many states, a single individual can form a corporation but some states require two or more entities (people or other corporations). Just as with an LLC, a corporation safeguards the assets of owners. A special type of corporation, an S Corporation (which you can “elect” to be considered directly with the IRS), even provides protection from double taxation.

Corporations offer many benefits over sole proprietorships or other unincorporated businesses. Corporations can be sold or transferred to new owners, plus they are legal, separate entities. This means that your corporation can own property, be sued, enter into binding contracts, and almost anything else that can happen to an individual person. You can also sell shares of your corporation in order to raise capital for your business ventures.

In most states you will also have requirements to keep up your corporation–such as holding meetings with your board and recording minutes. However, some states will also allow you to be the only board member, so the meetings don’t have to be super scary.

P.S. When you establish a corporation, you will begin to pay yourself as an employee and/or shareholder of the corporation. You won’t want to just take money out of your accounts however and whenever, you’ll want to be more purposeful and leave a clean, legal, sensible trail with all your payments.

How/where to file: To form a corporation, you will file “Articles of Incorporation” and any other necessary forms with your Secretary of State office or your state’s commerce office.

Nonprofit Corporation

A corporation created for some type of public benefit is called a nonprofit corporation. Nonprofits do not necessarily have tax-exempt status, but you can certainly apply for such status under IRS Code, section 501(c) (3).

Since most small businesses are created to make profits for you as the owner, a nonprofit corporation is unlikely to be the best business structure for you. Whereas you could pay yourself as one of the members of your nonprofit organization, you wouldn’t be keeping the “profits” of products you sold or services you rendered in the same way as you would with a for-profit business entity.

How/where to file: A nonprofit corporation is formed in a very similar way to a corporation (i.e. with your Secretary of State).

Special State Business Entities

When you research LLCs and corporations with the proper state office, you may also find that each state has special/different entities outside of the ones listed above. Read up on them (carefully)—some are only for professionals such as doctors and attorneys, and others may place limitations on your business/activities that you don’t want. Always read the fine print.

Some Important Notes for All Business Types

Please note that where you choose to file your business entity (and no, you don’t have to file in the state you live in for LLCs and corporations), you may have different franchise taxes, laws, and requirements that affect your business.

For example, in Texas, your LLC costs $300, you don’t have to renew it every 3 years, and you don’t have to pay the 1% state franchise tax until you make about $1,000,000 or more. You must research carefully, and perhaps even call around to different state offices to make sure you are in compliance with your business. You’ll also want to understand whether the products and services you render require you to collect and pay sales tax.

The Benefits of Hiring and Attorney or Using Another Service Provider to File Your Business Paperwork

Many individuals choose to seek an attorney’s help when forming their business entity. This can be an extremely wise step since a lawyer is likely to be familiar with the legalities, requirements, and potential pitfalls of each business type.
Luckily though, the formation paperwork for most entities is generally easy enough to understand that you don’t necessarily need outside help.

However, if you feel uneasy about filing it on your own, ask help from someone who has filed the same forms before, or consider hiring a lawyer or using a company such as LegalZoom. You can visit LegalZoom.com for professional help filing any of the business entities listed above. For a reasonable fee, companies such as these file the paperwork for you and ensure that it will be filed correctly, even to the point of assuming responsibility for any errors on their part.


Business Insurance

There are multiple types of business insurance you can obtain for your company, your employees, and your company property. When searching the Internet, or calling around for insurance rates, below are some of the main types of coverage you can look for.

General Liability Insurance

This will cover lawsuits and the possible payments that may arise due to medical expenses, injury, negligence or slander.

Example: A customer spills her drink and someone else trips and falls in your store, breaks his arm, and sues you for negligence because you didn’t have a “wet floor” sign up.

Errors & Omissions Insurance (or Professional Liability Insurance)

Service businesses use this type of insurance to protect against payments on claims related to malpractice, errors, or omissions in the service of clients.

Example: A bride and groom who sue for damages against a photographer who accidentally loses his camera and memory card after shooting their wedding.

Product Liability Insurance

If your company manufactures, sells, or distributes products, product liability insurance can protect you against financial losses due to products that cause harm.

Example: Someone claims your jewelry made her skin break out, and she decides to sue you for the medical expenses.

Property Insurance

This type of insurance protects the cost of business property (building, equipment, money, documents, etc.) from fire, hail, crime or other disturbances. Property insurance policies vary as to what types of “perils” they protect from, so make sure you get a policy that covers all the possible perils you are concerned about.

Example: Someone breaks in and steals your computers (with all your business or client documents) and expensive laser printer.

Owner’s Health Insurance

Your health insurance will be what reduces or eliminates costs for doctor’s visits, medical care and surgeries, medicine, and more.

Owner’s Disability Insurance

You may really want to consider an insurance policy that will kick in if you are unable to work for a time due to serious injury or illness. Most of these plans will begin to pay you a reasonable percentage of your salary after 60 – 90 days of your inability to work. Depending on your business (whether you have employees, high overhead expenses, etc.), you may want to seek a disability policy that will cover your business, not just your personal living/salary.

Select-Your-Business-Insurance-Worksheet

Workers’ Compensation Insurance

Required in most states of businesses that hire employees outside of their immediate family, workers’ compensation insurance covers medical expenses and lost income, or permanent disability, for employees injured on the job. Personal disability insurance is another type of insurance that has benefits similar to workers’ compensation but is available for the business owner.

Business Automobile Insurance

If you conduct business with your vehicles (e.g. delivery, limousine, janitorial service/supply transport) then business auto insurance will insure your vehicles and provide injury or loss coverage.

Home-Based Business Insurance

Since most homeowner’s or renter’s insurance policies do not cover business losses, you may want to obtain home-based business insurance to cover your business property.

Other Industry-Specific Insurance Types

Many businesses in your city or state may require specific insurance, certifications, licenses, or permits; common examples of such businesses are taxi services, janitorial services (or other services where you enter people’s homes), businesses that sell liquor, restaurants or other food establishments, dance studios, automotive shops, and the like.

Zoning, construction, signage and many other items can be regulated by the city. Insurance and certifications may be required by your state. Most likely, a simple visit to your city’s website or call to your city’s small business or commerce office can lead you to all the information you need on which permits, insurance policies, and licenses are required for your business.

How much will insurance cost?

Premiums on these insurance policies vary greatly, but discounts are often available through memberships in professional groups and associations. Another way to cut costs is to outsource certain business functions that potentially increase your liability (e.g. the delivery of certain goods). But honestly, I’ve always been pleasantly surprised by insurance premiums, so the best thing to do is get on the Internet and check out available rates.


So, how do you feel about selecting your business entity and/or insurance now? I really recommend pouring your favorite beverage and settling in for some serious research about your state, your business, and your specific needs. Don’t forget to use your worksheets to take notes. Oh, and if this post helped you, please consider clicking below to tweet it and share it with friends. I appreciate it.

Choose your business entity and insurance

Thank you for reading, ninja.
Regina out.

Main blog post photo: (c) BONNINSTUDIO
Blog post image design + graphics: Regina Anaejionu

9 responses to “How to Choose Your Business Entity and Business Insurance”

  1. Asuka says:

    Thank you, Regina!
    I’m not in the US but the info you provided here is really valuable for me!
    I’ve always learn from you a lot.

    With LOVE xx

  2. Jon Butt says:

    This is fabulous info, Regina. You should start your own business school 🙂

  3. Latreace says:

    Thank you for this amazing info, as a young entrepreneur, I have a lot of work cut out. Never realized how much business development, legally and protection wise I would have to do.

  4. Patti says:

    Tweeted and pinned…thank you.

  5. Jenn says:

    This is a great article – thank you for writing it. I’ve been reading a lot about this lately. I found out that forming an LLC or corp might not protect me from accusations that my blog writing defamed somebody or had wrong info that caused someone a problem. It would work if I hired writers and they (arguably) did something wrong, but not when the writer is also the owner of the company.

    Apparently for that I need something called “media liability insurance”, and it’s pretty expensive. Once I’ve done a little more research, I’m going to go to an expert and make sure I’m right about all this. It’s confusing, figuring out what you need for a digital business. Everything is designed for brick-and-mortar businesses.

  6. Dania says:

    Excellent post, Regina! I’ll be referring back to it from time to time. You do amazing work! 🙂

  7. Thanks for this post here this amazing post i can say this is really a very precious for everyone.i also share this with my friends they also appreciate this.

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