The only decision more intimidating than choosing to start a business, in general, is deciding on a business structure. Different business types can offer different advantages and disadvantages to new entrepreneurs, but don’t fret! This article aims to demystify the various business structures so that you can choose the best one for your entrepreneurial pursuits.
Key Takeaways:
- Business entities can function as various business structures.
- The unique standards associated with each structure can impact a business’s legal liability, taxes, and other operational factors.
Sole Proprietorship
A sole proprietorship is a type of business entity wherein an unincorporated business is owned and operated by an individual. Sole proprietorships are also often called sole traderships, proprietorships, or individual entrepreneurships.
In this business structure, the sole proprietor maintains total control of the business, and there is no legal separation between the business and its owner. Therefore, the business owner is responsible for the business’s taxes and liabilities and receives all profits generated by the business.
According to statistical data, profits for sole proprietorships are on the rise. The most recent IRS statistics for 2021 show that profits for nonfarm sole proprietorships were up a whopping 22% to $411.3 billion.
Pros & Cons
What Businesses It Is Right For
A sole proprietorship can be the right choice for a variety of individually owned and operated small businesses. Some examples of the companies that may qualify as sole proprietorships include:
- Freelancers
- Independent contractors
- Gig economy workers
- Self-employed workers that do not have employees
Learn more:
General Partnership
A general partnership is a business type wherein two or more persons, also known as general partners, enter into an agreement to establish and run a business together. General partners share duties running the business.
General partnerships conduct business for profit, and all general partners involved hold responsibility for the business. Additionally, general partners are subject to unlimited legal liability for the organization.
Pros & Cons
What Businesses It Is Right For
General partnerships are best applied in situations where the participants perform work within the same industries, like service providers, or when individuals wish to work together closely on a business. The following business situations are often organized as general partnerships:
- Spouses or partners conducting business together
- Law firms
- Dental practices
Learn more:
Limited Partnership
Limited partnerships are business entities formed by two or more persons, and that include one or more general partners and one or more limited partners. In this structure, the general partner(s) have unlimited personal liability, whereas the limited partner(s) liability is limited to their investment in the company. Limited partnerships operate in accordance with a partnership agreement that is drafted to cover the ways a limited partnership will operate.
According to IRS data on partnerships from 2021, limited partnerships represented just 9.9% of all partnerships. However, limited partnerships reported 36.1% of all pass-through income and included the largest share of total partners (34.0%).
Pros & Cons
What Businesses It Is Right For
Limited partnerships can be the ideal business structure for business owners within a variety of industries. The following are popular examples of businesses that are often structured as limited partnerships:
- Private Equity (PE) firms
- Venture Capital (VC) firms
- Hedge Funds
Learn more:
Limited Liability Partnership (LLP)
Limited liability partnerships are not to be confused with limited partnerships or limited liability companies. Instead, LLP businesses are partnerships of two or more persons, who each have business asset protection in the case of another partner’s negligence.
LLPs can offer greater flexibility when it comes to the business’s operational management, as the partnership’s operation and profit distribution are determined between the partners within the partnership agreement.
Pros & Cons
What Businesses It Is Right For
Small business examples that fall under the limited liability partnership structure most often include individuals operating within a professional service firm. Examples may include:
- Lawyers working at law firms
- Accountants working in accounting firms for financial advising businesses
- Physicians or dentists in medical practices
Learn more:
C Corporation
C corporations, or C-corps, is a legal structure for businesses where the entity is owned by its shareholders. C-corp entities are taxed separately from their owners. This means that the profit incurred by a C-corp is taxed twice, both at the entity level as business income and at the shareholder level when profits are realized as capital gains or distributed as dividends.
Once formed, a C-corp is a separate entity from its owners, offering owners limited liability protection. Another beneficial aspect of C-corps is that they can be more attractive to investors than entities with an S-corp or LLC status. This is because C-corps have fewer restrictions for accepting venture capitalist financing than S-corps or LLCs, and many business owners choose this entity structure for this reason.
Pros & Cons
What Businesses It Is Right For
While C-corps are commonly used by larger structures or those seeking investor funding, the fact that C-corps are taxed twice may inhibit small businesses with fewer resources from choosing this entity option. However, C-corps may be the right choice for the following types of small businesses:
- Public companies
- Small businesses looking to scale up their operations
- Businesses with over 100 shareholders that are required to organize as a C-corp
Learn more:
Limited Liability Company (LLC)
Limited liability companies (LLCs) are a highly popular form of business entity, with LLCs making up the majority of all partnerships (71.7%) for the 20th consecutive year according to 2021 IRS data. However, single-member LLCs can also be operated by individuals, making them a great choice for solo entrepreneurs looking to start a small business.
An LLC is a business entity wherein the owner’s personal assets are protected from legal claims made against the business. LLCs offer the best of both worlds, as they provide the limited liability protection of S-corp entities in addition to the flexibility of partnership business structures. LLCs can include single members or unlimited members. They differ from limited partnerships, as liability protection extends to all entity members including those with managerial authority.
Pros & Cons
What Businesses It Is Right For
LLCs can be the right choice for business owners who want to pay lower tax rates but also wish to protect their personal assets, making them popular among higher- or medium-risk businesses.
Businesses in many industries take advantage of the LLC structure’s pass-through tax benefits and liability protection, especially when they are initially formed and throughout their early years.
The following list includes examples of well-known companies that formed as LLCs:
- Google LLC
- IBM Credit LLC
- Hertz Vehicles LLC
- Amazon Services LLC
- ExxonMobil Sales and Supply LLC
- Johnson & Johnson LLC
Learn more:
Nonprofit
A nonprofit business entity is a variation of a traditional C corporation that does not operate for profit. Instead, these corporations operate to benefit the public and often uphold missions that support social, scientific, educational, religious, or charitable causes. Additionally, these entities must follow rules established to ensure that they are politically nonpartisan. By complying with these guidelines, nonprofits can experience benefits such as receiving liability protection and having the ability to file for tax-exempt status.
Nearly two out of every three nonprofit jobs (66.3%) in 2022 were in the social assistance and healthcare sector, according to data from the Bureau of Labor Statistics. Still, nonprofit organizations are involved in all industry sectors, with others that had high shares of nonprofit employment including educational services (16.4%); other services (6.3%); and arts, entertainment, and recreation (2.6%).
Pros & Cons
What Businesses It Is Right For
Nonprofit corporations are founded to serve a charitable cause, and therefore reinvest their revenue for the purposes of fulfilling their mission, rather than distributing that income to shareholders.
A nonprofit business structure may be ideal for entities that function for the purpose of supporting charitable causes. Examples of these types of organizations include:
- Religious organizations
- Social and fraternal organizations
- Veterans’ organizations
- Volunteer fire departments
- Schools
- Youth organizations
- Library support organizations
Learn more:
Joint Venture
A joint venture (JV) is a type of business that is formed when two or more entities decide to combine their resources to fulfill a specific goal. A joint venture is temporary in nature, and is considered its own entity that is separate from its participants’ other business undertakings. It enables businesses involved to leverage each expertise, and strengths, so that they can maximize their capacity to achieve their mutual goal.
In a survey conducted by Boston Consulting Group (BCG) of 159 executives from companies with worldwide joint ventures, the majority of respondents (60%) said that JVs are more resilient vehicles in times of economic downturn compared to outright acquisitions. JVs can offer advantages over acquisitions, in cases where partners are seeking short-term business arrangements, and wish to retain a higher degree of autonomy.
Pros & Cons
What Businesses It Is Right For
Joint ventures can be highly beneficial for parent companies of any industry that wish to unite their resources to fulfill a shared goal. Common small businesses you might see using this business structure include:
- Technology companies who combine data to support their mutual missions (for example, GE and Microsoft creating the joint venture Caradigm to improve healthcare quality)
- Service providers who combine similar offerings to attract customers create ( for example, Spotify and Hulu worked together on a joint venture to offer a combined subscription bundle at a discounted price)
- Businesses that wish to share expertise to expand their product offerings (for example, Polaris and Zero Motorcycles formed a joint venture to integrate Zero Motorcycles’ cutting-edge electric powertrain technology with Polaris’ off-road vehicle design and engineering experience and develop new off-road vehicle products)
Learn more:
Common Business Designations
Any conversation about business structure is incomplete without discussing S-corps and B-corps. Though they each have “corp” in their names, S-corps and B-corps are not exactly business structures. S-corp is a tax designation and B-corp is a business certification.
They are worth mentioning in any conversation about business structure, for two reasons:
- Many people confuse them for business structures.
- Many business owners make the decision to add an S-corp designation or B-corp certification to their business at the same time they are deciding on their business structure.
Both S-corp designation and B-corp certification can apply to multiple business structures. To obtain either of these designations, your business must already be organized by one of the business structures listed above. Here’s a quick sketch of each, along with pros and cons and further reading to help you decide what’s best for your business.
S Corporation
S corporations, or S-corps, are business entities that elect to pass corporate profits, losses, credits, and deductions through to their shareholders’ tax returns. In doing so, these “pass-through entities” themselves don’t pay federal income taxes; only their shareholders do. So S-corps and their owners and partners avoid double taxation on corporate income, as they are not taxed at the entity level. Instead, shareholders are responsible for paying federal income taxes on their share of the S-corp’s income based on their individual income tax rates.
S corporations are currently gaining popularity, with S corporations making up 76.6% of all U.S. corporations according to data from the U.S. Bureau of Economic Analysis. The tax implications of this business structure make it an appealing choice for small businesses.
Pros & Cons
What Businesses It Is Right For
To designate as an S-corp, you first need to structure and register your business as either an LLC or a C-corp. So multiple small business types can become S-corps. S-corps have restrictions regarding the number of shareholders the corporation can have, which can be advantageous for smaller businesses that wish to limit the number of owners in their organization. Examples of small businesses that may benefit from an S-corp business structure include:
- Retail stores
- Car dealerships
- Movie theaters
Learn more:
Benefit Corporation
A benefit corporation, also commonly referred to as a B-corp, is a type of for-profit business that has received certification from B Lab, a non-profit company that measures a company’s social and environmental standards. To receive certification, B-corps must uphold high standards and have a commitment to corporate social responsibility, through verified performance, transparency, and accountability.
Business owners may decide to register their business as a B-corp as a way to attract consumers, since buyers often choose to support brands that uphold social and environmental values. According to B Lab, there are currently over 6,000 Certified B corporations in more than 80 countries and spanning over 150 industries.
Pros & Cons
What Businesses It Is Right For
B-corps can be ideal business structures for small or large businesses that are dedicated to social responsibility, and that meet B Lab’s standards for social and environmental performance. Any business structure type, from a sole proprietorship to a partnership or C-corp can apply for a B-corp certification. Some examples of small businesses that may qualify as B-corps include:
- Small apparel brands that donate clothing items to people in need with every customer purchase
- Organizations that sell products using 100% sustainable packaging
- Organic farms that use sustainable agriculture practices that protect the environment
- Food service companies and other businesses that raise donations to fund food access
Learn more:
How to Choose the Right Business Structure Type
Selecting the right structure for your small business is important, as it can impact the business’s liability, taxes, and other key factors. Follow the steps outlined below to help you choose the ideal structure for your small business.
Step 1: Consider the Different Types of Business Structures
Review the unique standards, operational guidelines, and requirements for each business structure to narrow down which types could apply to your small business.
Step 2: Determine the Level of Personal Liability Protection Your Business Requires
Evaluate the needs of your small business to identify how much personal liability protection you require. Consider how the different structures available to your business approach liability protection for business owners.
Step 3: Understand the Tax Implications of Different Business Structures
The structures outlined within this article each have their own tax requirements. When choosing a structure for your small business, consider how their tax requirements would impact your business’ tax obligations.
Meeting with a tax professional may be helpful for choosing the best structure for your business’ unique tax needs. Other professionals who may be able to provide valuable information about different business structures include business advisors, accountants, and lawyers. Consulting with these professionals can help you understand each business structure’s aspects before you make your decision.
Step 4: Consider the Level of Control You Desire Over Your Business
As a business owner, your control over business decisions can depend on the type of business structure you choose. For example, partnerships require multiple partners to share the responsibility of decision-making, whereas sole proprietors operate individually and retain full control over business decisions.
Step 5: Consider How Your Business Will Raise Capital
Some business structures, like corporations, are attractive to investors as they can issue stock. On the other hand, other structures have limited access to outside investments, like sole proprietorships and partnerships. Consider whether your small business would need to raise capital from investors, and how each business structure would impact this process.
Step 6: Analyze Costs & Complexities Associated With Each Structure
Filing fees, paperwork, and regulatory compliance can be a headache for small business owners but may be unavoidable for certain business structures. Assess the complexities and costs associated with each structure, and consider how these factors would impact your business processes.
Step 7: Consider How Each Structure Would Support Your Long-term Business Goals
The long-term goals of your business can be more or less achievable depending on which structure you choose. For instance, small businesses that plan to scale quickly would benefit from a structure that allows them to easily raise significant capital, like a corporation. However, by selecting an LLC structure, this process wouldn’t be as easy. That said, try to choose a business structure that aligns with the long-term goals of your small business.
Frequently Asked Questions (FAQs)
Each offers different aspects to business owners, regarding tax benefits, levels of liability protection, and regulatory requirements. Review the following frequently asked questions to help you determine the best business structure for your small business.
Partnerships, sole proprietorships, corporations, and limited liability companies (LLC) are considered to be the four main types of business structures.
The 10 types of business structures include partnerships, sole proprietorships, limited partnerships (LPs), limited liability partnerships (LLPs), limited liability companies (LLCs), S corporations (S-corps), C corporations (C-corps), nonprofits, cooperatives, and franchises.
Bottom Line
Choosing a business structure for your organization is a vital decision that can influence your organization’s future operations, legal responsibilities, and overall success. Therefore, consider the differing aspects of each structure to determine the best option for your unique organization. Factors like legal liability concerns, tax implications, management structures, and other administrative requirements can vary between structures and may influence your business’ future growth.
By choosing a business structure that is aligned with your organization’s current needs and long-term goals, you can position your business for future success.
This post was originally published on here
