A company needs to establish the correct legal entity to run a successful business. In the app development business, as in most other companies, there are four basic business structures from which to choose, including sole proprietorship, LLC, a C Corp, and an S Corp.
Each structure has its advantages and disadvantages that need to be considered before choosing one for your app development business.
Pros and Cons of a Sole Proprietorship
A sole proprietorship has no distinctions between the owner and the company itself. In other words, you are the sole owner, and all profits from this structure flow directly to you as an individual. This also means that you will be responsible for all of the debts and liabilities that may arise from your business.
Advantages of Sole Proprietorships:
- A sole proprietor is taxed as a regular taxpayer along with any other income they make from their app development business (you don’t need to pay corporate taxes).
- With this business structure, the owner is self-employed, so you don’t have to worry about formation or paperwork. This can be beneficial at the start of a business when there’s little need for funding. There are also no requirements for filing annual reports or paying fees to the state, which saves time and money during the initial stages of a business.
Disadvantages of Sole Proprietorships:
- Liability is the biggest issue associated with a sole proprietorship. The owner of this business structure is personally liable for any debt or legal consequences incurred by the company.
- Securing business loans can be difficult because there’s no collateral or separation between the business owner’s personal assets separate from those of the business.
- The lack of an established record-keeping system and the absence of a legal distinction between the business and its owner can make it challenging for a sole proprietorship to expand.
This is a great option for small start-ups because it doesn’t require much paperwork. But, there are risks with this option as if someone sues your business and wins, you will most likely have to pay for it personally.
Pros and Cons of an LLC (Limited Liability Company)
This is a business structure that provides limited liability to its owners and requires the filing of an LLC application with the state. You can even have a single-member LLC. The business owner or owners of LLCs are not held personally liable for the business debt and the business has a legal distinction from its owners.
Advantages of Forming an LLC:
- LLC owners do not have to pay taxes on their company’s losses and can choose how they want to be taxed, whether it’s as a sole proprietorship or partnership.
- LLC owners have access to a wider pool of resources and financing opportunities because the business is registered with the state. This type of legal entity also makes it easier for the company’s growth and expansion.
Disadvantages of Forming an LLC:
- App development business owners must regularly file documents with the state to maintain their LLC status.
- LLCs can grow more complicated and expensive to maintain over time due to other fees that are required by the state.
- As your company grows, it may need more legal counseling which can become costly.
In most cases, an LLC is a good business structure for an app development company that is looking to expand and grow into a larger venture with more employees.
Pros and Cons of a C Corp (C Corporation)
A C corporation is a type of corporation that is taxed separately from its owners. This means that the business pays income taxes on its profits and the shareholders also pay taxes on their dividends, even if those profits were taxed at the corporate level.
Advantages of a C Corporation:
- C corporations have the ability to raise money through selling stock, which can be helpful for some growing businesses.
- C corporations offer the opportunity for tax deductions that are not available to other types of business organizations. For example, a C corporation can deduct the cost of health insurance premiums for its employees.
This type of corporation is ideal for businesses that plan to have a large number of shareholders.
App development businesses that are looking to go public or partner with a larger company should consider a C corporation.
Disadvantages of a C Corporation:
- C corporations are more expensive and complex to set up than other business structures.
- C corporations are subject to “double taxation” on profits, which means the business and its shareholders are taxed on profits twice.
- C corporations are subject to greater government regulation than other business structures.
In general, a C corporation is a good fit for app development companies that want to raise money from outside sources and have a large number of shareholders.
Pros and Cons of an S Corp (S Corporation)
An S corporation is a type of C Corporation that the IRS designed to help small corporations minimize their paperwork while still gaining many of the tax benefits of incorporating.
Advantages of an S Corporation:
- S corporations can take advantage of the reduced liability benefits typically associated with a C corporation, while still enjoying the tax benefits of being a sole proprietorship or partnership.
- S corporations allow for pass-through taxation, which means there is no need to pay corporate taxes on company profits. The so-called “double taxation” issue of a regular corporation is solved with an S corporation because profits and losses are passed directly to the shareholders.
- App development business owners can reduce their risk of liabilities by limiting their personal financial responsibility for company debt and litigation.
Disadvantages of an S Corporation:
- S corporations have stricter requirements for shareholders and minimum distributions, which means a smaller pool of potential investors.
- An S corp is not allowed to have more than 100 shareholders. As a result, it can’t go public without first converting to a C corporation, and is somewhat limited in its ability to raise capital from investors (particularly individual investors, each of whom would be considered a shareholder).
In general, an S corporation is a great fit for app development companies. You avoid double taxation, can raise money from outside sources, and enjoy limited liability protection.
How To Choose the Right Structure for Your App Development Business
When it comes to choosing a structure for your app development business, the best option is often determined by how quickly and ambitiously you want to grow.
LLC and S corporations are better options for small businesses that hope to expand and grow into larger ventures with more employees. These structures help protect owners from personal liability issues while still allowing access to outside funding.
Sole proprietorships are good options for small app development businesses because they are quick and easy to establish, however, they offer limited liability protection
Overall, business owners should choose their business structure based on the type of work they do and their growth plans.
How to Legally File an LLC or Corporation for Your App Development Business
If you have made the decision to form an LLC or corporation for your app development business, it is important to understand the legal process and requirements for doing so.
In order to form an LLC, you must file Articles of Organization with your state’s Secretary of State. This document will outline the business name and purpose of your LLC, as well as the names and addresses of its members.
In order to form a corporation, you must file Articles of Incorporation with your state’s Secretary of State. This document will outline the name and purpose of your corporation, as well as the names and addresses of its directors and officers.
Both the LLC and corporate filing processes typically require fees, which vary by state.
It is important to note that both LLCs and corporations are separate legal entities from their owners, meaning that owners are not personally liable for company debts or lawsuits.
Suppose you need help filing an LLC or corporation for your app development business. In that case, it is best to consult with a tax adviser or an attorney who specializes in business law.
App Development Business Entities FAQs
The best business structure for an app development business depends on the type of work they do and their growth plans. For example, an LLC or corporation is a good option for small businesses that hope to expand and grow into larger ventures, while a sole proprietorship may be a good option for small businesses that don't expect to expand beyond a handful of employees.
Being a sole proprietor means that you are self-employed and own your business outright, so you are held responsible for all its debts and liabilities. All business income is also taxed as income on your personal tax return, including self-employment taxes.
On the other hand, an LLC offers limited personal liability protection for its members, and all income from the LLC is typically taxed at a lower rate than personal income.
Both LLCs and S corporations are good options for app development businesses who want the limited liability protection of a corporation, with favorable tax treatment, while still having access to outside funding.
An EIN, or Employer Identification Number, is a unique nine-digit number that is assigned to businesses by the Internal Revenue Service (IRS). It is used to identify businesses for tax purposes.
An app development business does not need an EIN unless they have employees. In that case, the EIN would be used to file employment taxes. This applies to both LLCs and corporations.
A sole proprietor does not need to have a separate business bank account, as all business income and expenses are considered part of the owner's personal assets. However, it is a good idea to segregate business and personal assets to make tracking and bookkeeping easier.
An LLC or corporation must have its own bank account, and all income and expenses should be tracked and filed separately.
Form a Business Entity as an App Development Company
If you are starting an app development company, you will need to decide what business entity to form. An LLC or corporation provides limited liability protection for its owners and offers tax benefits.
Consult with a tax adviser or business attorney to discuss the best legal structure for your app development company.