Types of Business Ownership: Everything You Need to Know
It is important that you choose the right structure for your business as the type of structure you choose will affect how your business is organized, taxed, and handled. 7 min read
Types of Business Ownership
Before you can determine how you want to structure your business, you'll need to know the types of business ownership out there. The below are your choices when it comes to running your business: sole proprietorship, partnership, limited partnership, limited liability company (LLC), corporation (for-profit), nonprofit corporation, and cooperative. It is important that you choose the right structure for your business as the type of structure you choose will affect how your business is organized, taxed, and handled.
A sole proprietorship is a one-person business that is not generally registered with the state. Advantages are that it is rather easy and straightforward to form, you need not worry about other opinions as you are the sole operator of your business, and there is very little government regulation on sole proprietorships. Some disadvantages include limited resources to financing, the business ends when the owner dies, and any losses must be specified on the owner’s personal tax return, meaning that the owner is personally liable for the company’s debts and obligations.
The most common type of partnership, a general partnership is arranged by 2 partners who will have unlimited liability, which means that their personal assets are liable to the partnership’s obligations and debts. The general partnership itself can be information—it can be as easy as a verbal agreement made over dinner. As long as the agreement is put into a written contract, you can create a general partnership.
There are no requirements to business formation with general partnerships. It is entirely up to the partners themselves to determine how to run the business. General partnerships are particularly an attractive type of business for those operating in the legal or medical field. For example, if two attorneys who operate as sole practitioners wish to expand their networks, they may choose to form a general partnership with the purpose of bringing their own specialized knowledge, expertise, and expansive network in hopes to further expand and develop their business.
However, a disadvantage of being a general partner, as previously noted, is the unlimited liability that you face. Therefore, you can be personally liable for the general partnership's’ debts and obligations to creditors, legal suits, and any other financial obligations that the general partnership is responsible for. For example, if someone brings a legal suit against the general partnership, both partners will be defendants in the suit. Moreover, even if you did not engage in any misconduct, if the court finds the general partnership guilty, then both general partners will be held financially responsible for the outcome of the suit.
Limited partnerships, or limited liability partnerships, are generally established for real estate purposes. When two or more partners form this kind a business, such partners will be liable only for the amount of capital each one invested into the business. Limited partners do not receive dividends but do in fact enjoy direct access to the flow of income and expenses. Generally, limited partners are not liable for the total and complete debts and obligations of the company. While the limited partnership is different than a general partnership, the limited partners can enjoy general partner-like qualities, including the ability to manage the business like a general partner would as long as a formal contract is in place. Be mindful that limited partnerships will have at least one general partner who controls the daily operations of the business, and who will become ultimately liable for all business debts.
An LLC, or a limited liability company, operates essentially as a corporation, sole proprietorship, and partnership all in one. An LLC affords its members with limited liability as they cannot be held personally liable for the company’s debts. An LLC is a sole legal entity; and the name you choose for your LLC is the legal name of your company. This means that the name of your company is the name you will use when conducting business. Some benefits of an LLC include:
- Being registered as an LLC can help you gain credibility with potential customers, vendors, partners, and employees.
- An LLC offers protection against personal liability, including personal assets; therefore, an LLC is the preferred business type when liability is an issue, i.e. when the company hires employees.
- Owners will not be personally liable for decisions or actions taken by the LLC.
- When your company expands, seeking funding is a much more straightforward process.
LLCs are formed under state laws - which vary state by state - when an individual files the Articles of Organization with the Secretary of State’s office in the state you choose to register. A name availability check can be conducted on the Secretary of State’s website in order to ensure that the name is not currently being used. An LLC business owner is required to report any changes in address, membership, or service and must also file an annual report that includes important business and financial information.
The legal name of an LLC lasts until the business is dissolved. Once an LLC is in existence, the owner has the option of also filing a DBA to conduct business under a name different than the registered LLC business name. The members of an LLC can choose whether they want to be taxed as a sole proprietorship, corporation, or partnership. LLC members owe Social Security and Medicare taxes, but such taxes can be paid through the members’ self-employment tax form. There may be certain tax deductions that an LLC owner can use that cannot be deducted through a DBA. On the contrary, the DBA confers no special income tax status, meaning the owner must pay taxes in accordance with its own filing status.
A corporation is a legal entity operating under the state laws in which the business is incorporated. A corporation is treated as a person for all intents and purposes. Therefore, a corporation can sue and be sued, buy or sell real estate, and even break the law. There are generally two types of corporations—S corporations and C corporations.
S corporations are pass-through tax entities whereas C corporations are completely separate entities from its owners. When choosing which type of business structure, whether it be an S or C corporation, you’ll want to consider both non-tax as well as tax ramifications. However, keep in mind that the only difference between these two types of corporations is with regard to taxation.
A significant distinction between C corporations and businesses that operate as pass-through entities is that owners of C corporations are taxed only on income received. Since a corporation is taxable, the profits leftover after being incurring corporate taxes are not taxed to the owners. Such profits are only taxed when distributions are paid to shareholders in the form of dividends. However, this would be the case for unincorporated businesses and S corporations.
There are several benefits to incorporating your business, which include:
- A business that is incorporated can file lawsuits and buy/sell property.
- Incorporation even means that the company can commit a crime, i.e. tax fraud or another type of business crime.
- Incorporating is simple. Simply file an application within the specific state.
- All 50 states, including the District of Columbia, recognize both LLCs and corporations.
- A corporation can evade double taxation of the profits and dividends by choosing Subchapter S tax status.
- Corporations can deduct normal business expenses before they apportioning income to owners.
- Corporations can easily transfer ownership through a transfer of securities to the new owner.
- Corporations can operate for an unlimited period of time.
- Corporations can create tax benefits but C corporations might be exposed to double taxation of profits.
- Those businesses set up as S corporations can pass through income to the shareholders.
- The IRS generally taxes corporations at a reduced tax rate than individuals.
- Corporations can issue shares of stock.
- A business that is incorporated can take its company public.
A nonprofit organization is one that has been established to meet certain tax exemptions and serve the public interest. All assets of a nonprofit must be reinvested into the organization, given to the public, or given to another charity. Should the nonprofit not meet the needs of the general public, its tax exemption benefit will be taken away.
Some benefits of establishing a nonprofit corporation include:
- Federal tax exemptions
- Obtaining private and public grants
- Low-cost postage
- Directors can serve with or without compensation
Although most would think that nonprofits can’t sell goods or services for money, you can. Many nonprofit organizations make money selling all types of products and services. Moreover, a nonprofit can also pay salaries for any employees who work there.
The most common type of business structure for a nonprofit is a corporation, which is formed and regulated under state law. Therefore, if a nonprofit incorporates, it must abide by the state requirements of a corporation. This includes:
- Drafting bylaws
- Filing the Articles of Incorporation with the state business registrar
- Hiring a board of directors/trustees
However, the nonprofit can still apply for tax-exempt status in an effort to avoid federal corporate income tax. Further, many states allow nonprofit organizations to avoid sales tax and property tax.
While nonprofits are generally organized as corporations, they can also be formed as LLCs in certain states, including Delaware, California, Michigan, Minnesota, and Texas. . While LLCs do not have tax-exempt status, a nonprofit operating as an LLC generally does so long as the LLC elects to be treated as a corporation for tax purposes. Furthermore, the LLC must have a non profit purpose, which some states simply don’t allow. For example, some states require that when a business registers as an LLC, the application must state the purpose of the business.
Nonprofits don’t have a specific economic purpose but are rather charitable organizations organized to serve the needs of the public. Therefore, certain states simply do not allow nonprofits to register as LLCs. It is important to note that on a federal level, the IRS will not give a nonprofit LLC tax-exempt status unless all of the members are tax-exempt organizations themselves. For example, if four tax-exempt charities come together to create a nonprofit LLC, then the LLC will benefit from federal tax exemptions.
In a cooperative, grassroots business organizers often refer to their business as a “group,” “collective,” or “co-op.” For example, a consumer type of co-op could be established to run a food store, bookstore, or other retail-related business. Some advantages to cooperatives include that they are owned and controlled by its members and there is limited liability. Some disadvantages include the risk of conflict between members and slow decision-making.
A syndicate is a self-organizing group of people or businesses that form together to transact specific business or to promote a common interest.
Organic growth is the process of businesses expansion due to an increasing customer base, output per customer, and/or through new sales.
If you need help choosing between types 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, Stripe, and Twilio.