One silver lining that Americans seem to have held onto after a tough economic climate in 2020 is the unprecedented increase in business startups. Economists labeled the sharp rise in new business applications in the third quarter of last year a “startup boom”.
Although fourth quarter leveled off, a recently released study found that, overall, Americans started 4.4 million businesses in 2020. This is an unprecedented 24% increase over the previous year, and also the biggest increase on record.
While the previous global recession in 2008 saw business formation sharply decrease because the cash crunch made it difficult for entrepreneurs to attract investment, new startups in the United States surged ahead of other rich countries in 2020. The main difference may be the tremendous governmental support in America for businesses and households, creating a supply of money greater than before the recession.
Common business formations
When an entrepreneur is deciding on the right business structures for their startup, it is important to understand the elements of liability, expenses and taxes, as well as which business formation is best suited to their style.
The business entities that are most often used in business formation are:
- Sole proprietorships, which have one owner and are not a separate legal entity
- Partnerships, in which two or more co-owners share profit and loss on their personal income tax
- Limited liability corporations (LLCs), which limit owner liability and have the advantage of pass-through profits and losses
- Corporations, which have a separate legal and tax entity
Sole proprietorships and partnerships create much higher levels of personal responsibility for the owners than do corporations and LLC’s, which shield the owners from liability, allowing them to take on more risk.
Owners of sole proprietorships, partnerships and LLCs must report and pay taxes on net profits of the business, even when they do not take funds from the business account during a particular tax period. Corporation owners, however, only pay taxes on profits in the form of dividends, bonuses and salaries.
While there are general considerations a new California business owner will want to take care of during the formation of the business, it is important to also have a knowledgeable and trusted legal source who will not only assist with entity selection, liability and insurance concerns, but can also draw up ironclad contracts to ensure that the new business is on solid footing from the outset.