All businesses fall into one of seven main types of business structures. These various business models exist because what works well for one type of business could be a disaster for another. The rules and regulations that relate to each business are very different, and the benefits of each are offset by the literal liabilities they bring. Let’s break down the different types of business structures.
Sole Proprietorship
A sole proprietorship is a company owned by a single person. It may be run by that person as well. This type of business is typically centered around a single service provider. It may be an inventor selling prototypes, an artist selling their wares, or a store owned and operated by one person.
A sole proprietorship is easy to set up. However, the business owner is liable for the business’ debts, and the business owner could be sued personally when the business is considered liable. A sole proprietorship can’t sell shares in the firm. You’ll have to pay personal income taxes on the profits from your business.
General Partnerships
A partnership is similar to a sole proprietorship except that there are several partners. Everyone in the partnership shares in the profits and the losses. Partnerships are rather easy to set up. The minimum number of partners is two while adding too many people to the partnership can make decision making hard. Partnerships don’t pay the same taxes large corporations do, but the partners will pay taxes on their percentage of the business income.
Too many partnerships fall apart because they built a business on an informal agreement. They don’t have a plan for handling someone who needs to cash out their shares due to death, divorce or disability. Or they lack a plan for a partner choosing to leave the firm. In short, while you do not have to file paperwork to start a partnership, you should have a formal agreement behind it.
A Limited Liability Partnership
A limited liability partnership or LLP, unlike a general partnership, requires paperwork and legal fees to set up. They are typically set up by several “general partners”. New, limited partners can be added later on. The main benefit of the limited partnership is that it limits personal liability. This is essential in a medical or legal firm where you want to limit the liability of a lawsuit to one member.
The general partners of the partnership handle day to day operations. General partners are personally liable for judgments against the firm and its debts. They share all of the business profits and pay personal income taxes on their share. Limited partners are not personally liable for business debts or legal liabilities.
C Corporations
A corporation is simply a company run by people who own shares in the company. These shareholders determine how the company runs, and they select the person who will run the company. Shareholders will receive a portion of the profits based on how many shares they hold. One benefit of corporations is the relative ease for selling shares to raise capital, and banks are more willing to lend them money.
Another benefit of setting up a corporation is that it is separate from the people who work there. The owners aren’t personally liable if the business is sued. Shareholders can sell shares to others and get their cash out of the business. The corporation can continue to exist long after all of the shareholders have left, and the founders have moved on.
There are downsides to running a corporation. The complex organizational structure means it is typically slow to make decisions. They must meet strict organizational standards. Corporations tend to pay more in legal fees and taxes.
S Corporations
S Corporations are slightly different from the standard corporation. They pass all losses, profits and tax deductions to the shareholders. The shareholders have to pay personal income taxes on the profits. The business cannot have more than 100 shareholders, and they all have to be American citizens or trusts and estates based in the U.S. The main benefit of an S corporation is the degree of legal protection they provide beyond what a partnership would have.
Limited Liability Companies
Limited liability corporations or LLCs are a relatively recent business structure; they were first codified into law in 1977. They combine elements of the partnership with a corporation. Unlike a corporation, the LLC is not its own separate tax entity. Owners must pay personal income taxes on their share of the profits. The only exception is when the LLC specifically asks the IRS to be taxed as a corporation.
What are the benefits of an LLC? The LLC offers a level of protection for the owner or owners. The owners aren’t personally liable for the debts of the business, and if the business is sued, their personal assets aren’t at risk. An LLC is ideal for those in high-risk business ventures that are liable to be sued. An LLC is a good idea if the business owner has significant assets they don’t want to risk losing if sued when something goes wrong. And an LLC is the better choice if you’re going to go deeply into debt to finance a project. However, those are not the only benefits of an LLC.
LLCs are simpler to set up than a corporation. The simpler business structure allows for faster decision making. Yet any member of the LLC can have a vote in the running of the organization, whereas a limited partner has no say in an LLP.
A Co-Op
A co-op is a business owned and operated by the members of the cooperative. Cooperatives tend to be small, and they typically provide a service to the members. Common types of co-ops include grocery stores and childcare centers. The laws related to co-ops depend on where you live. Note that a co-op is also different from a non-profit corporation, a relatively new entity that isn’t addressed here.
Conclusion
Perhaps the biggest business decision you can make is the type of structure your new business will have. Each structure has its pros and cons, so choose wisely.
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