Corporate Forms of Business Ownership
When you start your business, choosing a legal structure is one of the first and most important decisions you'll have to make.3 min read
The most common corporate forms of business ownership are:
- Sole proprietorships.
- Limited liability companies (LLC).
- Corporations (for-profit or nonprofit).
When you start your business, choosing a legal structure is one of the first and most important decisions you'll have to make. Your choice will determine:
- How your business is taxed.
- How complex your paperwork will be.
- The liability you will take on personally.
- Your ability to take out loans to grow your company.
When you are making the decision about how to organize your business, consulting with a professional is wise, but you can and should do a fair amount of research yourself. Business formation is governed by the state law where you organize.
A sole proprietorship has just one owner. The positive side of this form of business ownership is that it is the simplest, the easiest to set up, and the least expensive to run. Making decisions in a sole proprietorship is very simple and straightforward. This may be the best choice if you are the only owner and you have no need to separate the identity of the business from your personal identity.
The downsides of a sole proprietorship can be significant. The sole proprietor is completely liable personally for all activities of the business. That means he or she is responsible for the debts of the business if the company can't pay, and his or her personal assets are at risk.
The owner is responsible for all the profits, losses, assets, and liabilities of the company, for good or bad. For those reasons, this is probably not the best choice for someone in a high-risk type of business. Sole proprietors are also required to pay self-employment tax on income they realize from the business.
If your business requires significant borrowing, then the sole proprietor form of operation may not be the best choice. If your personal financial history is not very strong or if you are likely to be sued for the activities of the business, then it's wise to choose a different legal structure to protect your personal assets. Sole proprietors may find some protection in a business insurance policy.
Limited Liability Company
Limited liability companies (LLCs) are somewhere between a corporation and partnership. However, they are not incorporated, so they are not considered corporations. This form offers the business owner some protection for his or her personal assets. This structure also gives the owner some protection from personal liability for the activities of the business.
However, the owners of an LLC should understand that they do not enjoy full immunity from liability. Owners can still be held responsible for deliberate fraud, reckless behavior, illegal actions, and failing to separate business and personal activities.
For most small businesses, the LLC structure is preferable to forming a corporation. The LLC has greater flexibility in handling profits and management decisions, especially if several owners are involved.
In a corporation, the owners are called stockholders. They have limited liability for the actions of the company, but they also have limited involvement in the day to day operations. This is one of the most complicated forms of business to run in terms of taxes, record keeping accounting, and general paperwork. Shareholders report the money they earn on their personal income tax returns, which lets them avoid the double taxation that happens with other business forms.
A partnership involves two or more partners who maintain personal liability for the debts of the business. Any partner can be held responsible for the actions of the business, and each partner holds decision-making authority.
One special type of partnership is a limited partnership in which only one partner can make decisions for the company and can be held personally liable. The other partner(s) are investors in the business but don't make day to day decisions.
Another type of partnership is the limited liability partnership, or LLP. This structure is commonly used in professional associations of doctors and lawyers. The LLP structure is not available in every state, and regulations vary widely. If you are considering this structure, you'll want to research your local jurisdiction's requirements carefully. In a partnership, the gains and losses the partners realize pass through to the individual tax return.
If you need help with choosing a corporate form of business ownership, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.