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 are likely to impact its operations as well as its profits. Hence, it becomes important to identify an appropriate legal entity, prior to signing the dotted lines on the franchise agreement.
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Pros & Cons of legal structure options present for Franchise business
- Limited Liability Co. (LLC): Franchise business mostly uses LLCs as it is offered with adequate protection from claims arising from personal liability. Being independent legal entities, they can enjoy greater flexibility and less of statutory requirements. But 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 partnership & sole proprietorships: For the Franchise business, such entities are not viable. Only small businesses can enjoy benefits from such models due to its tax structure. But individual stability is not provided any protection. General partnership and sole proprietorship are considered to be the same for personal legal identity and not separate. Hence, claims and liabilities, if any, need to be obliged by the franchisee.
- S-Corporations: Lucrative tax structure is what has made this model popular among Franchise business. Since profits & losses are distributed among shareholders, federal IT returns are not necessary. Shareholders are required to report such information using K1Form on personal tax returns. Franchisees consider it to be a wonderful legal structure, as they have limited shareholder numbers, who assume tax liability, irrespective of profits earned or not.
Also Read: How to Be a Good Franchisee
- C-Corporations: The franchisor can find this model to be more beneficial when compared to the franchisee. This is because of its equity investor distribution. Publicly trade organizations having several executive boards and equity investors can find it viable. But franchisees will find it troublesome since C-corps get taxed both at individual and corporate levels. Its objective is to position the future growth of the business by compelling investors to provide additional capital investment. If rapid growth is expected by the franchise at some point in time, then this structure is held ideal to enjoy reduced taxes. However, starters will not find it ideal.
So, getting to know the above structures will help you to choose the best legal structure that will be most appropriate for your Franchise business.