Trying to determine the very best legal structure for your new franchise business is indeed a crucial decision. The challenge involves tax implications and legal obligations since the franchise’s legal structure is likely to impact its operations as well as its profits. Hence, it becomes important to identify an appropriate legal entity before signing the dotted lines on the franchise agreement.
Pros & Cons of legal structure options present for Franchise business
Limited Liability Co. (LLC):
Franchise businesses mostly use LLCs as they offer adequate protection from claims arising from personal liability. Independent legal entities can enjoy greater flexibility and fewer statutory requirements. However they are likely to face challenges, especially when offering equity to potential investors, as unlike corporations, there is no even distribution. If multiple investors exist in a franchise, then, from a tax perspective, LLCs are found to be much more complex to manage.
General partnerships & sole proprietorships:
For the franchise business, such entities are not viable. Only small businesses can enjoy benefits from such models due to their tax structure. However individual stability is not provided with any protection. A general partnership and a sole proprietorship have the same personal legal identity and are not separate entities. Hence, claims and liabilities, if any, need to be made by the franchisee.
S-Corporations:
Lucrative tax structures are what have made this model popular among franchise businesses. Since profits & losses are distributed among shareholders, federal IT returns are not necessary. Shareholders must report such information using K1Form on their personal tax returns. Franchisees consider it a wonderful legal structure, as they have limited shareholder numbers who assume tax liability, irrespective of profits earned or not.
C-Corporations:
The franchisee may find this model less beneficial compared to the franchisor. This is because of its equity investor distribution. Publicly traded organizations with several executive boards and equity investors can find them viable. C-corps get taxed at both individual and corporate levels, causing trouble for franchisees.Its objective is to position the future growth of the business by compelling investors to provide additional capital investment.If the franchise is expected to experience rapid growth at some point in time, then this structure will enable us to enjoy reduced taxes.However, starters will not find it ideal.
So, getting to know the above structures will help you choose the best legal structure that will be most appropriate for your franchise business.
