Ways to Structure a Business: Everything You Need to Know
There are many ways to structure a business, such as sole proprietorship, partnership, limited liability company, corporation, or nonprofit.3 min read
There are many ways to structure a business. For example, you may decide to create a sole proprietorship, partnership, limited liability company, corporation, or nonprofit. Which structure you choose will determine how the business operates and submits to taxation.
How to Choose a Business Structure
Selecting your business structure is one of the biggest decisions you'll make when starting a new endeavor. The choices range from a basic sole proprietorship to a C corporation most commonly used by large Fortune 500 companies. The structure you choose will dictate important issues, such as:
- Tax treatment
- Legal liability
- Management options
- Day-to-day operations
- The amount of paperwork involved
- Business costs
- The kinds of shareholders or investors you can have
There is no one-size-fits-all solution, so you'll need to determine what aspects you need in a business and what your future plans are in seeing that business grow.
The most common forms of business are:
- Sole proprietorships
- Limited liability companies (LLCs)
- Limited liability partnerships (LLPs)
- S corporations
- C corporations
Most experts recommend creating an LLC in most situations because it's the easiest, most flexible structure for new entrepreneurs to afford.
No matter which structure you choose, it's important to reassess your business from time to time to see if you should switch structures to maximize benefits. Switching a business structure can get complicated, but it's sometimes necessary if a company has grown beyond its initial scope. Just be sure to notify the IRS and your state tax agency that you've restructured the business.
Personal Asset Risk
One of the key factors in deciding which business structure is right for you has to do with personal asset risk. When you run a business, you're more likely to be sued for a number of reasons. That's because businesses interact with the public more than individuals, and when money's involved, disagreements are more likely to occur.
If you have a sole proprietorship and are sued by a disgruntled customer, your personal assets including your bank account, vehicles, and even your home are at risk because a court may liquidate these assets to pay for damages.
If you default on a business loan, the lender can place a lien on your assets and attempt to recover debts from your own personal property. Creditors will even go after the personal assets of an entire group of owners in a general partnership just to collect debts.
Limited companies, however, are different because they offer personal liability protections. LLC and LLP members are only responsible for business debts up to the amount they've invested in the company. Any personal assets remain protected. Corporations also enjoy limited liability to protect shareholder interests.
Business Tax Structures
Aside from liability issues, how a company is taxed is another main reason to select your business structure carefully. Sole proprietorships, partnerships, S corporations, and some LLCs are pass-through entities, meaning that the profits are passed directly to the business owners and all taxes are reported on their personal tax returns. The business itself is not directly taxed.
LLCs are considered pass-through tax entities by default unless you choose to be taxed as a C corporation. Since C corporations are considered separate legal entities from their owners, profits are taxed at the corporate level and again at the personal level because shareholders pay taxes on dividends.
Do you see yourself managing your company or hiring others to run it for you? When multiple owners are involved, structuring a business gets more complicated.
Partnerships and multi-member LLCs typically have operating agreements that define the company's management structure and how profits and losses are divided among owners. The operating agreement will also indicate what happens if a partner retires, becomes disabled, dies, or declares bankruptcy.
By law, a corporation must have a board of directors to oversee the business on behalf of the shareholders. An LLC is less formal because members can opt to manage the business themselves or hire outside managers to act on their behalf.
Most non-corporate business structures are relatively easy to manage because they require less paperwork and fees than corporations. In fact, LLCs, sole proprietorships, and partnerships are so easy to manage that you may not need special expertise except in certain circumstances.
If you need help deciding how to structure your business, post your job 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.