Types of Business Structures: Everything You Need to Know
When you begin your business, you will have to determine which types of business structures there are to adopt.7 min read
Types of Business Structures
When you begin your business, you will have to determine which types of business structures there are to adopt. Such a decision will affect how your company operates as well as how it is taxed. It will also affect the filing fees, level of paperwork involved, and other important decisions regarding the company’s daily operations.
Below are the various business structures you can choose from when determining how to structure your business:
- Sole proprietorship
- Limited partnership
- Limited liability company (LLC)
- Corporation (for-profit)
- Nonprofit corporation
If you’re in business for yourself and no one else, then a sole proprietorship is the way to go. Keep in mind, however, that you can’t hire employees. A sole proprietorship is a one-person business. It is the simplest type of business structure to establish; and has its advantages and disadvantages. One of the most significant advantages to establishing a sole proprietorship is that you have complete control over your business, including all decisions regarding financial matters as well as the daily operations of the sole proprietorship.
However, a disadvantage of this business structure is the liability that an owner incurs for the business’s debts and obligations. Unlike an LLC, an owner of a sole proprietorship is financially responsible for all of the business’s liabilities. Therefore, you are placing your assets at risk, and even your own personal property can be seized to satisfy a legal judgment. Another disadvantage to a sole proprietorship is the difficulty in raising money as a lot of financial institutions and other financing resources may be hesitant on providing funding to a sole proprietor.
Partnerships: Limited vs. General
A partnership is an entity formed when at least two or more individuals agree to go into business with one another. More specifically, there are two main types of partnership structures, which include general partnerships and limited liability partnerships, also referred to as limited partnerships.
There are no filing fees associated with establishing a partnership nor are partnerships required to hold meetings, prepare meeting minutes, appoint officers, or issue shares of stock. Keep in mind, however, that creditors can initiate legal proceedings against the partnership itself, including the assets of the partners, i.e. house or automobile.
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.
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.
Some advantages of forming an LLC include:
- Operating 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.
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 advantages 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.
- 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
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.
If you need help choosing between types of business structures for your company, 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.