Choosing the Right Business Entity as a Franchise

Choosing the correct business entity is one of the most critical decisions for a franchisor or franchisee. So, your choice lays the foundation for your financial future, liability exposure, and operational structure. You shouldn’t take this decision lightly, as it depends on personal, financial, and business-related factors unique to your franchise.

Understanding Business Entity Types

Most business entities are classified based on liability protection. This critical feature is missing in some entities, such as sole proprietorships and partnerships. Without liability protection, your assets can be at risk if the business becomes debt or is sued.

For most franchises, the decision narrows to two key options: To include corporations and limited liability companies (LLCs). Both provide liability protection for your assets from business obligations. It’s wise to contact a franchise business attorney for advice specific to your situation.

Corporations: Structured for Growth

A corporation’s ownership is tied to stock shares, and the corporation is a highly structured entity. These stocks are owned by shareholders, who elect a board of directors to oversee the company, and officers run day-to-day operations.

Separate taxation is one defining feature of corporations. The corporation is taxed on profits, but shareholders are taxed on the dividends they receive, sometimes called “double taxation.” But not all corporations are alike.

C corporations follow this dual taxation model, whereas S corporations forego corporate taxation and pass profits through directly to shareholders. If your business fits the criteria, you can qualify as an S-corp. The nuances that make corporations so appealing to franchises looking to scale and get access to a lot of investment.

LLCs: Flexibility and Simplicity

Limited liability companies offer liability protection with operational flexibility. Owners, called members, can manage the business or appoint a manager to do the job. Unlike corporations, LLCs are not subject to double taxation. Members report earnings on their tax returns, and profits pass through to them.

One significant advantage of an LLC is its adaptability. The number of members is unlimited and may constitute diverse ownership structures. This flexibility can be a game-changer for franchisees with ever-changing goals or ownership needs.

Factors to Weigh When Choosing

Your choice between an LLC and a corporation depends on your business type. The more owners involved, the more appealing a corporation might be.

There are financial considerations. When your franchise capitalizes on significant investments from several stakeholders, corporations are often a better framework for raising capital. Yet, LLCs may reduce administrative expenses and file fewer tax returns.

It’s not set in stone, your choice. You may discover that your initial business entity no longer fits your franchise. Fortunately, most states allow you to change your entity type, but you must comply with state laws. Legal counsel can work with you to keep the process going without hiccups.

Choosing the correct business entity is complicated, but you don’t have to do it alone. Legal and financial advisors are a massive help in weighing the pros and cons of each option. An experienced attorney can help ensure that the franchise you are starting complies with state laws and protects you from potential pitfalls when transitioning entity types.