5 Questions to Determine the Business Legal Structure for Your Franchise

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Because many franchisors require a formal business legal structure before granting a license to own one of their franchise operations — and because it’s smart to protect yourself from liability — it makes sense to consider one for your franchise. Each structure has its advantages and drawbacks, so you need to do your homework and think plenty before you make a decision.

By Nellie Akalp

Limited Liability Company (LLC), S-corporation, or C-corporation? Which should you choose? Many considerations come into play, and it’s important to consult with both legal and accounting professionals for guidance to make sure you understand all the pros and cons. Asking yourself these questions might also help franchise businesses determine the best option that suits their indivudal needs:

Does the franchisor require a specific structure?

If the franchise agreement states you have to set up your business a certain way to purchase and run the franchise, then your decision will be an easy one.

How much insulation against liability do you need?

Both LLC and S-corporation protect your personal assets because you are considered separate from your business entity. With an LLC, yours and any other members’ personal assets will be protected against debts, losses, and court rulings against your business. With an S-corporation, personal assets are typically protected and usually only money invested into your business by you and any other shareholders is at risk. C-corporations offer a higher degree of limitation on liability, applicable to directors, officers, shareholders and employees.

How will each structure affect your taxes?

One of the most appealing aspects of the LLC is its “flow through taxation.” In other words, profits are taxed at the individual level, on members’ personal income tax forms. With C-corporations, business profits are double-taxed (taxed at the business tax rate when they’re earned and taxed again when distributed as shareholders’ dividends). Also, income and loss gets reported at the corporate entity level, so you and other shareholders can’t deduct any of your business’s losses on your personal income tax returns. S-corporations offer the most flexibility; you can either opt to be taxed like an LLC (with flow through taxation) or as a C-corporation.

What level of complexity do you want to deal with?

Setting up and operating as an LLC offers simplicity. You’ll have less formation paperwork and compliance requirements than with an S-corporation or C-corporation. When you set up your business as an S-corporation or C-corporation, you need to follow a number of internal and external corporate formalities, such as adopting bylaws, holding shareholder and director meetings, filing annual reports, and other requirements to stay in good standing with the state you’re incorporated in. C-corporations come with more government oversight because of their complex tax rules and higher level of liability protection.

How much growth do you anticipate?

With an LLC, stock is not sold, so you don’t have shareholders as a source for generating funds for growing your business. An S-Corporation may sell shares of stock, however, the number of shareholders allowed is limited to 100, you can’t have entities (such as partnerships and corporations) as investors, and you’re allowed only one class of stock. A C-corporation has no cap on how many shareholders it may have, so there’s virtually unlimited opportunity to grow.

Choosing your franchise’s legal structure can impact your liability, tax bill, administrative burden, and ability to grow your business — don’t jump in and make a rash decision. It’s recommended to learn as much as you can about the advantages and disadvantages of each structure so you’ll feel confident in your choice.

And after you have decided, make sure you have all the i’s dotted and t’s crossed when incorporating your franchise or forming your LLC. If you file information incorrectly, it could delay the process and result in an administrative mess. It’s better to get it right from the start, so don’t hesitate to enlist the help of a legal professional or a business document filing service in managing all of the applications and paperwork.

Nellie Akalp is Founder & CEO of CorpNet.com. She is an entrepreneur, small business advocate, speaker and author.