Choosing the type of business structure can have lasting impacts on your business.
March 18, 2020 4 min read
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Building a solid foundation is the key to any business. Choosing the type of business structure can have lasting impacts on your business, including day-to-day decision-making and operations, paperwork and more. Each model also treats tax liabilities differently.
There is no one-size-fits-all structure, with each structure providing unique benefits and liabilities. This article will focus on five different corporate structures, taking into account legal liability, costs, taxes and flexibility.
Choosing your business structure
In persuing the right business structure for your business, consider what other small businesses in your field are doing. For example, technology companies will typically have different structures compared to a law firm. While better understanding your field will help in the decision-making process, each business is unique with different needs. You will also want to understand the following factors and how they may impact your business:
- Legal liability
- The future needs of your company
Next, let’s take a look at the most prominent structures available.
Sole proprietorships are the easiest businesses to form, and they give the owner complete control of the company. Any organization is automatically considered a sole proprietorship if the owner doesn’t register as otherwise. This is typically the most cost efficient when starting out.
In this case, the personal assets and liabilities go together with business ones when it comes to taxes. So, the owner can be held accountable for the debts and obligations of the company. As the company grows, so does the potential legal liability of the owner.
If two or more people own a company together, they form a partnership. Two prominent types of such organizations are limited and limited liability.
In limited partnerships, only one partner has unlimited liability. Other partners have limited liability as well as limited control over business operations.
The latter kind is similar. The main difference is that every owner has limited liability. That way, all partners have protection from the partnership’s debts, and they’re not responsible for the activities of other associates.
Limited liability company (LLC)
LLCs allow owners to enjoy the benefits of both corporations and partnerships. They protect from personal liability and avoid corporate taxes by taxing company revenue through personal income statements. The only catch is that members have to pay self-employment taxes.
If you decide to form an LLC, though, remember that they have limited life in many states. In some cases, every time a member joins or leaves it, you need to dissolve and reform it.
In general, these entities offer a high level of protection for their owners. However, this feature comes at a high cost, with many fees and a lot of paperwork.
There are five main types of corporations. Below, we’ll take a quick glance at them.
- C Corps are legal entities separate from their owners. They can earn a profit, pay taxes, and be liable legally. C Corps pay income tax for their revenue and have a separate life from shareholders.
- S Corps have the goal of avoiding double taxation of regular corporations. Some losses and profits can pass through the owners’ income statements without becoming subject to corporate tax. This structure also comes with several limitations.
- B Corps or benefit corporations are different from regular corps in purpose and transparency, but not in taxes. Their focus is both mission and profit, producing a public benefit as well as financial gains.
- Close corporations are similar to B Corps, but with a less traditional structure. The shares can’t get traded publically, and shareholders run such entities without the need for a board of directors.
- Nonprofit corporations do charity, educational, literary, scientific and religious work. They get tax exemptions because their work benefits the public, which means they don’t pay income taxes. Other rules for organization are the same as with a regular corporation.
Cooperative businesses and organizations are owned by those using their services and operated for their benefit. The members, known as user-owners, distribute the profits.
In most cases, an elected board of directors runs the cooperative, and regular members have voting power. Members become part of such a business entity by purchasing shares.
The Bottom Line
If this is your first time venturing into a startup, you may find the choice of a structure confusing and even intimidating.
It’s an important decision, but it doesn’t have to be an issue if you get informed before you choose. Understand your options and be logical about it, and you’ll be confident in your decision.