There are a lot of exciting aspects to opening a gymnastics gym: getting the keys to the building, installing the equipment, gym management software, signing up your first member. Deciding on the business structure of your gym is a far more mundane, but absolutely vital, ingredient. It will, however, have a huge impact on the future of your business. Still, it’s a topic that can get very murky for the uninitiated. In this article, we demystify the subject to help you decide which is the best structure for your new gymnastics business.
Main Business Structures
There are four main business structures:
- limited liability companies (LLCs)
- sole proprietorships
- partnerships (general and limited)
The right structure for your gym will depend on such things as how many people will own the business, and the types of services you’ll be offering to your members. If you and you alone are the business, you clearly won’t be considering a partnership. If you’re going to be providing services that involve a degree of physical risk then you’ll need as much protection from liability as possible, including protecting your personal assets. And, if you intend to raise funds by selling stock, then you need to lean toward a corporation.
It pays to consider these types of questions before delving into the pros and cons of each business structure. This will provide you with some initial direction.
The Issue of Liability
Before we investigate the characteristics of each of the four business types, it is important to note the major point of distinction between them – personal liability.
If you choose to use a sole proprietorship or a partnership structure, you will not have protection from personal liability. That means that, if things turn to custard, your business creditors will be able to come for your personal possessions, such as your house. However, forming a limited liability company or a corporation sets up the business as a separate legal entity. That protects you from incurring personal debt and lawsuits.
Clearly, having personal liability protection is preferable to incurring personal liability. However, LLCs and corporations are more work and cost more money to get established. It should be kept in mind, however, that there is nothing to stop you from getting established as a sole proprietorship or partnership and then switching to an LLC or corporation later down the track.
A Risky Business
Operating a gymnastics business is definitely one of the more risk-inherent endeavors that you could involve yourself in. Your risks will probably revolve around issues involving caring for children, overseeing physical activities that could lead to injury, and moving heavy equipment around the facility. As a result, you will want to have as much protection as possible, both against personal financial liability and against legal action.
When you are starting out, you need to determine whether or not business insurance will give you enough protection. Let’s take a look at the types of insurance cover you should put in place before opening your doors …
- General Liability Insurance – this will cover your legal defense fees and any ensuing judgment if you are sued. For $1 million worth of general liability coverage, you will pay between $400-1000. The price you pay will be determined by your location, the size of the deductible, how many employees you have, and any per-occurrence limit.
- Commercial Property Insurance – this will cover your equipment and other stock contained within the facility in the event of fire, earthquake, or other Acts of God.
- Professional Liability Insurance – this will protect the business against liability resulting from an employee mistake or a failure to perform.
If you choose to form an LLC, you will still need insurance. This structure will protect you from personal liability, but it won’t protect the business from liability. LLC Liability Insurance will add an extra layer of protection. Again, there are 3 main forms …
- Professional Liability Insurance provides business protection in the case of ‘errors and omissions.
- General Liability Insurance covers the business against claims that result from physical, personal, or property injury.
- Business Interruption Insurance covers the loss involved when normal business is interrupted following a disaster.
A Business Owner’s Policy for LLCs combines these three types of insurance at a reduced rate. Total annual insurance costs for a Business Owner’s Policy can cost anywhere between $650 and $3500 depending on location and number of employees.
Let’s now break down the characteristics of each of the business structures.
A sole partnership is a business that you set up and run by yourself. In this set up, you truly are your own boss. You get to make all the decisions – and bear all the responsibilities. If you are married, your spouse is legally allowed to do unpaid work for the business without being considered a partner or an employee of the business.
Setting up a sole proprietorship couldn’t be easier. In the vast majority of jurisdictions, there are no requirements to file specific documents or pay fees. All you need do is indicate that you are a sole proprietorship when applying for a business license.
When you operate a sole proprietorship, the government does not consider you and the business to be separate. As a result, you don’t pay separate taxes for the business. When it comes to filling out your tax return, you list the incomes and losses of the business on your personal tax declaration. The IRS refer to this as ‘pass through taxation’ because the profits or losses pass through you to be reported to them.
The only difference to how a person who is not in business fills out their tax form is that you will need to complete a profit and loss sheet (known as Schedule C) in addition to the 1040 tax declaration.
A benefit of incorporating your business and personal taxes is that in the event that the business shows a loss, which is typically the case in the first year, you can use that loss to offset any personal debt you may incur to the IRS.
As previously touched upon, as a sole proprietor, you are liable for the debts of the business. You can and definitely should protect the business with commercial insurance cover, but you cannot purchase insurance to protect you from business debts. The only way to do that is to form your business as an LLC or a corporation.
A partnership is similar to a sole proprietorship except that it has more than one owner. There are two types of partnerships …
- General Partnerships
- Limited Partnerships
The difference between them comes down to liability. In a general partnership, each partner is liable for the debts of the business. A creditor can sue any of the partners for the full amount of the debt (even though the partner may then turn around and sue the other partner for their portion of the loss).
Another feature of a general partnership is that each of the partners has binding authority over the business. That means that one partner can legally make a business decision and commit to it without consulting the other partners. So even if you were unaware that your partner made a purchase, you will be personally liable if the business couldn’t pay for it.
This underscores the vital necessity of choosing your business partners very carefully.
Limited partnerships do provide some protection for partners in the event that the other partner acts injudiciously. However, this form of partnership is quite rare, being mainly seen in legal partnerships and the like.
It is imperative that you and your partner complete a partnership agreement, though there is no legal requirement to do so. This agreement will spell out what share of the profits each partner will receive, what duties and responsibilities they will perform, and what will take place if one of the partners leaves the business.
Here is what should be included in a partnership agreement …
- Name of partnership and partnership business
- Date of partnership creation
- Purpose of partnership
- Contributions (cash, property, and work) of each partner to the partnership
- Each partner’s share of profits and losses
- Provisions for taking profits out of the company (often called partners’ draws)
- Each partner’s management power and duties
- How the partnership will handle the departure of a partner, including buy-out terms
- Provisions for adding or expelling a partner
- Dispute resolution procedures
It is also a good idea to complete a buy-sell agreement when you are setting up the partnership. This document will detail what will occur if one of the partners dies, retires, or gets divorced (in the case of both marriage mates being partners).
Limited Liability Company (LLC)
The main reason that new business owners avoid a limited liability company business structure is fear of all the red tape that is involved in the process. The reality is that the red tape is not as bad as most people think. In fact, an LLC provides the personal liability of a corporation while also retaining the pass-through taxation of a sole proprietorship or a partnership without the raft of legal obligations that come with a corporation.
As the owner of a limited liability company, you will not be personally responsible for the debts of your gymnasium. You will also be immune from personal legal liability in the form of lawsuits. The business creditors will certainly be able to lay claim to everything that the business owns, right down to the last paper clip, they cannot come for your personal possessions.
There are, however, certain situations where the individuals who form an LLC can be held personally liable. These situations apply equally to corporations. They are …
- If you make a personal written guarantee on a loan to the LLC. Banks will often stipulate that they require a personal guarantee, which will invalidate your LLC protection.
- The IRS may pursue corporate Federal and State tax debts of the business from the individuals who make up the company.
- Negligent or Intentional Acts on behalf of an LLC member can result in a personal lawsuit.
- Breach of fiduciary duty, in which an LLC member does not act in the best interests of the company. This usually involves fraud or other illegal activity.
- Blurring the boundaries between the LLC and the owners. You can avoid this by keeping separate bank accounts for the business, maintaining separate accounting books, and getting a federal employee identification number.
You can form an LLC by yourself or with partners. It should be noted that the same binding authority rules apply to LLCs. So, if your LLC partner unilaterally commits to a contract or business transaction, the entire LLC is bound or contracted. In this sense, you need to be just as careful about who you form an LLC with as if you were going into a partnership with them.
When it comes to taxation, an LLC is considered to be a pass through business. As a result, you do not have to complete a separate tax declaration for the business. Each LLC will pay tax on its share of the profit or claim its share of the loss.
With an LLC you are given the option of having the business taxed as a corporation. The reason that LLC members may choose to have the business treated as a separate entity at tax time is that the income splitting strategy of corporations can allow LLC members to come out ahead by having their business taxed as a separate entity at corporate tax rates.
If your gym managed to turn a profit over the year, you can save money by paying corporate tax rates as they start out lower than individual rates.
An LLC will cost more money to get established than a sole proprietorship or a partnership. In the United States, you will need to file articles of organization with your Secretary of State or other LLC filing office. Filing fees vary quite markedly from state to state. The filing fee in Illinois is $500, whereas in California it is just $70. However, you will also need to pay a minimum annual LLC tax in California when you start your LLC.
These up front expenses can be a real challenge for a brand new business. That’s why many of them start out as a sole proprietorship or partnership and then form an LLC a couple of years down the road. Corporations are even more expensive to set up than an LLC.
Corporations are not all huge behemoths like McDonald’s or Apple. In fact, most of them are rather small operations with just a handful of employees. A corporation is simply a legal structure for a business that imposes legal and tax rules upon its owners.
Like an LLC, a corporation is a separate legal entity from its owners. The corporation itself is subject to income tax and the owners of the business are known as shareholders. A corporation can go through the process of listing on the stock exchange and selling shares in the business to the public.
Private companies are owned by individuals who are actively involved in the running of the business, whereas public companies are listed on the stock exchange. Public companies are heavily regulated by state and federal security laws.
LLCs vs Corporations
You may be surprised to learn that LLCs are a relatively new business structure, only coming into being in the 1970s. The first Limited Liability Company was formed in Wyoming in 1977. Prior to then, the only way to protect yourself from personal liability was to form a corporation. Many small businesses didn’t want to be bothered with all the red tape and expenses involved so chose to carry the risk of personal liability by sticking with a sole proprietorship or partnership.
A type of compromise was the establishment of the ‘S’ Corporation, which acts like a normal corporation, except that business profits pass through to the owner, rather than being taxed to the corporation at corporate tax rates. As a result, you could enjoy the personal liability of a corporation while still getting the pass-through taxation of a sole proprietorship or partnership. However, many of the corporate aspects of corporations still apply to S Corporations.
Here’s a breakdown of the differences between an LLC and an S Corporation ….
- S Corporation members are maxed out at 75 and must be US citizens or US residents / LLC membership is not maxed out and is open to anyone.
- S Corporation shareholders must distribute profits according to the percentage of ownership / LLC members can distribute profits however they see fit.
- To maintain their limited liability status, S Corporation members must follow corporate rules regarding issuing stock, electing officers, holding regular board of directors’ and shareholders’ meetings, keeping corporate minutes of all meetings, and following the mandatory rules found in their state’s corporation code. / LLC members do not have to do any of these things.
- S Corporation business debts can not be passed along to its shareholders unless they have personally co-signed and guaranteed the debt / LLC members can claim business losses on their personal income statement.
- There is time and expense involved in forming an S Corporation. To protect their limited liability status they also have to act like a corporation, which means adopting bylaws, issuing stock to shareholders, maintaining records of various meetings of directors and shareholders, and keeping records and transactions of the business separate from those of the owners. These involve lawyer, accountancy, and other professional fees. / LLC members do not have these expenses or time commitments.
- S Corporations are able to claim a range of fringe benefits, including health and disability insurance / sole proprietorships, partnerships / LLCs cannot claim these expenses.
What is the Best Structure for your Gym Business?
Even though we have broken down a whole range of differences between the four business structures, for most people the issue comes down to one thing …
Which will provide the best personal liability for the owners in terms of business debts?
This natural desire to protect oneself from financial liability if things go bad needs to be balanced with the need to outlay as little money as possible on the legal structure of the business as they struggle to get up and running.
The reality of the situation is that many start up businesses can quite safely get themselves established as a sole proprietorship or a partnership. Once they are established and have a flow of money coming in, they can then consider either an LLC or a corporation.
When it comes to deciding between an LLC or a corporation, many business owners decide that it really only makes sense to form a corporation if they need to take advantage of a corporate stock structure to generate investment capital. Issuing stock options to employees can also be an incentive to attract top level staff.
But if you don’t have plans in the foreseeable future – or ever – of taking your company to the stock exchange, it will probably make more sense to create a limited liability company. They are simpler to set up, less expensive, require far less red tape, and allow you to benefit from pass-through taxation.
You now have a thorough understanding of your business structure options for your new gymnastics business. While the decision you make is completely your own, let me conclude by sharing the structure that I set up when opening my own gym a few years back.
I was opening a general fitness gym to cater to about a thousand members. I began as a sole trader but made sure that I had a full package of insurances, including general liability, commercial property, and professional liability. It wasn’t until the 3rd year of the business that I moved into a limited liability structure. That structure worked well for me and many of the gym owners that I have worked with over the years have followed a similar evolving structure.
I encourage you to use this article as the springboard toward choosing the best business structure for your gymnastics gym based on your personal circumstances.