Have you ever noticed how strong buildings are built? Whether it is a towering skyscraper or a family home, every building has one thing in common – a solid foundation. The same goes for having a good business. You need to choose a business structure that is the best for your business and its goal. That is how you can be sure to grow, evolve, and stand the test of time.
When you are working on starting your own company, you will need to lay out the right foundation with the best business structure that would help you move towards success in the future. But how to determine which one is the best business structure for your small business? That is where this article would help you.
A business structure of a company is the organization of it in regard to its legal status. Selecting the best business structure appropriate for your company would create a legal recognition for your trade. Not just that, a business structure defines how the company would look and in running the business successfully. For example, it offers you the best approach to deal with your company’s tax liabilities. It will help you understand your responsibilities and duties as an owner. You will be clear about the various legal documentations you need.
And all this depends completely on the jurisdiction in which you established your business. The company’s business structure would also show all the possible personal liabilities that the business owner/owners would incur in case there is any trouble in the company or it is sued. For you to choose the business structure that is best for you, you will have to consider all the aspects of it, such as the setup costs, liability rules, legal rules, and so on.
Why is choosing the right business structure important for your company?
When you choose the best business structure for your business, it will help you in a lot of ways. It would affect the way you pay taxes, how much taxes you pay, the level of liability or risk your personal assets (house, car, and so on) would have, and even the company’s ability to raise outside investment and grow into an empire.
Common Types of Business Structure
There are many business structure types in the USA, but some of the most common ones are those mentioned below:
#1 Sole Proprietorship
The simplest business structure is the sole proprietorship. In fact, if you do not want to start a separate legal entity, you are a sole proprietorship. This means that you can operate the company under your own name or under a trading name. Anyone can open a sole proprietorship. As a matter of fact, if you are already offering some services under your name, you are a sole proprietorship. This means that you do not need any official registration to start a sole proprietorship.
Nonetheless, you still need to get the permits and licenses for the kind of service you are offering. It is best to check with the local secretary of state’s website to see what you need to do. And if you are planning to do business under a trade name, this trade name would have to be registered as a DBA (Doing Business As).
One of the main advantages of the sole proprietorship is that it is inexpensive and simple. When you choose this business structure, the main disadvantage is that it does not create a separate legal separation between your personal assets and the business ones. This means that if you are sued, or your business goes bankrupt, your personal assets would be used to pay off all the legal liability and creditors. Here are the advantages and disadvantages of this business structure.
- This structure can be a great option for low-risk business owners who want to test their idea before they launch a business with it.
- The taxes are considered “pass-through” where the profits earned are mentioned on the owner’s personal income tax return – that is on the Schedule C and Schedule SE on the 1040 tax form.
- It is the quickest and easiest structure that you can form where the owners then have total control over everything in the business.
- Although this is the best business structure for a small business, it does not offer any protection against liability and risk. So, if there is any legal issues or financial struggle, the owner’s personal assets would be used to pay off all the credit and debts.
- It is not easy to get any outside funding for a sole proprietorship due to the high personal risk and lack of business partners. This business structure also cannot sell shares in the market in exchange for funding, which also restricts its options for obtaining capital to help the company grow.
A partnership is just like a sole proprietorship, but with more than one person. Let us say that you decide to be a nutritionist and start a business as a sole proprietorship. But then, you get an idea to connect with a yoga trainer to give better services. You meet someone and become partners. This is now a partnership and not a sole proprietorship. The partners would share the profits and losses of the business.
But it is not this simple too. Partnerships change a lot. And there is a Uniform Partnership Act that governs the partnerships in many states. As per this Act, there needs to be a specific partnership agreement that would act as the legal core of the partnership, which would be different for each partnership.
The tax treatment is the same as the sole proprietorship where the owners report the profits and losses through their personal income tax return. In addition to this, there are different risks involved in a partnership, which is why you can choose from a general partnership and a limited partnership.
To help you better, here are the different types of partnerships you can choose from:
- General Partnership: If you choose this business structure, it is assumed that all partners are involved equally; that is in terms of duties, liabilities, and profits are all distributed equally. In case there is an unequal split in the partnership, it has to be noted on the partnership agreement.
- Limited Partnership: A limited partnership is normally used for those partners who serve as the investor in the company. They have limited input in the company and in running it. It is a more complex structure, and less frequently used.
- Joint venture: In case you want to collaborate with someone just for one project then the joint venture is a great idea. They work the same as the general partnership but just for a short period of time, that is till the specific project runs.
To make sure the partnership goes smoothly, it is crucial to signify what would happen when a situation comes up like when one partner buys out the other, or withdraws, or dies. Whatever you want to do, ensure that you have a lawyer with you guiding you properly at each step. Forming a partnership is just like forming a sole proprietorship. You do not have to register the business. But if you want to do business with a trading name, you will have to file for the DBA. You might also need some additional licenses and permits based on what you are offering and the location of the business. Here are some advantages and disadvantages of a partnership.
- Partnerships are considered to be “pass-through” entities for tax purposes. The partners have to file form 1065 with their personal taxes. They also need to report their income on a Schedule K-1.
- In case you are a general partner of the limited partnership, you will have most of the control in the company.
- You share both the reward and risk of running the business with your partner in a partnership.
- Limited partnerships have a lot of paperwork, which makes it more complex than a normal partnership.
- Even though the limited partnership offers the partners some liability and risk protection, these partners do not have any control over the company and its operations.
- General partnerships offer no protection of any personal assets. So, all partners are equally responsible for the legal and financial troubles.
#3 LLC or Limited Liability Company
In the above two business structure types, if the business goes bankrupt or ends up in bad times, does the idea of being personally responsible for the losses sound okay? Well, that is why the Limited Liability Corporation was created. An LLC has the benefits of both the partnership and the corporation. You get the flexibility of the partnerships and the limited liability protection of the corporation.
This is the best business structure that offers a combination of limitations on legal liability and favorable tax treatment for transfer assets and profits. But you need to know that even though the benefits are the same for LLCs formed in any state, there are some rules that slightly vary from state to state. You will need a lawyer you help you determine if an LLC is better or a corporation is better for you.
This is the best business structure for a small business, especially if you do not want to be personally liable for anything that happens with the business. With this, you will be able to not just protect your assets if the company goes bankrupt, but also if someone sues your company. The process of forming an LLC is more complex than a sole proprietorship. Basically, you need to choose a compliant business name and then file the articles of organization.
Once done, you will need to make an operating agreement that defines how the company would run and the roles of each member of the company. The next step is to obtain all the various industry-specific permits and licenses that are needed for the company, based on the industry it belongs to and the location of the company. Here are some of the advantages and disadvantages of an LLC.
- The LLC separates the personal and business assets allowing you to easily protect your personal savings, home, and car from any lawsuits faced by the company.
- They are considered a “pass-through” entity just like the sole proprietorship where all the profits and losses are filed on the personal income tax return of the owner. This means that the LLC does not pay any corporate taxes. The owners need to file Schedule C and Schedule SE along with their personal 1040 tax form.
- LLCs are very flexible and can be managed by multiple owners or even just a single owner.
- LLC requires a lot of paper and legwork as compared to the other business structures due to the legal requirements, forms, and state filings.
- LLCs are not indefinite entities. Each state has different regulations for the LLC formed in that state. So, you might have to dissolve the business in that state and form it again, if you want to form it in a new state, the owner leaves, or a new owner is added.
A corporation is one of the most common business structure types where it offers the option to have many shareholders, great tax treatment, limited liability protection, and even a great structure. Along with this, it also has a more complex legal structure. There are three kinds of corporations – C corporation, which is a standard corporation, a small business S corporation, and the benefit corporation or the B corp. The C corporation is the most sought after business structure in the USA by those entrepreneurs who wish to grow an empire and turn the company into a public company someday.
To form a corporation, you will have to register your business name, file the articles of incorporation, and then get the Federal Tax Identification Number (also known as the EIN or the employer identification number). A corporation can switch from S to C corporation and back, but not so often and the process isn’t that easy as well. In fact, the IRS has created stringent rules regarding how the switch can be made. So, you will need an attorney or professional help when you are about to do this.
Here is some more about the different types of corporate business structures that you can choose from:
Also known as the C corp, a C corp is an organization where all the shareholders can combine their funds to build it and are offered stock of the company in return. It is a separate legal entity in the eyes of the IRS, which means that it can make business tax deductions unlike any other kind of business structure. But this also means that the earnings of the company are taxed twice, once at the corporate level and then the dividends are taxed at the personal level. Although this might be negative, if you plan the taxation properly, you can easily benefit from it.
That being said, the C corporation has double taxation since it usually has different goals and objectives. It often wants to grow and go public, or it already is public and expects that the profits earned by the company are used to grow the company and not go in the pockets of the owners. The C corporation is also said to offer the best shielding from personal liability for the owners, and also offers the best non-tax benefits.
Those companies that want to enjoy the benefit of being able to raise huge investments for the company and eventually go public consider the C corporation. It is the best business structure for this type of business goal. Here are some advantages and disadvantages of the C corporation.
- C corps usually remain unchanged during the event of a shareholder or owner leaving the company.
- They can sell the stock of the company, which then helps when cashflow is needed. It also acts as a great benefit for potential employees.
- Shareholders and owners are protected with a C corporation since their assets would never be at risk when there is any financial and legal difficulty.
- C corps usually face double taxation, once at the corporate level, and then again on the dividends when paid out to the shareholders at a personal level.
- Due to the structure, C corps have a lot of requirements and regulations to follow including reporting and filing.
- The C corps are normally more expensive to form as compared to the other business entities.
The S corporation is similar to the C corporation but with just one major difference – the profits and losses can be “passed-through” to the shareholder’s personal tax return. It means that the shareholders would pay tax on the profits earned on their personal income tax return only and not on the corporate level as the C corporation requires. In short, profits are taxed once. This is also the best business structure for family companies or small ownership companies.
In a lot of states, the S corporation is owned by just a few private owners, at max 25. And only individuals can hold stock in an S corporation, while both individuals and companies can hold stock in a C corporation. To be able to become an S corp, you will have to first step the company as a corporation (which is a C corporation) and then request for the S corp status from the state with the form 2553. Here are some of the advantages and disadvantages of the S corporation.
- This structure operates as a separate entity from the owners, so when a shareholder or owner leaves or passes away, the business continues.
- Since it is a pass-through entity, it is not subjected to double taxation like the C corps.
- They offer limited liability protection to all the owners and shareholders.
- S corps are restricted to just one class of stock, which means that they might have more issues in raising capital.
- They are considered to be domestic businesses, where all the owners have to be US residents or citizens.
- They have more restrictions than the C corps and can have a maximum of 100 shareholders only.
B corporation: This is very different from the above two and is dedicated to a social mission. Its benefits are the same as the C corps but some states offer a lot of tax breaks to the B corps as it stands for a cause.
Choosing Right Business Structure
To choose the best business structure for your small business, you will need to consider the following factors and then make your choice:
- Liability: One of the main things you need to see when you are about to start your business is personal liability. You do not want to lose all your personal assets in case the company is sued.
- Complexity: It is essential to choose the level of complexity you are okay with. Understand where you want to see your company headed to and what your goals are before choosing one of the business structure types.
- Flexibility: Choose the business structure that offers you to have all the flexibility. And the structure that offers this is an LLC, as compared to the other structures.
- Capital investment: The next thing that you need to see is how much you are able to invest or willing to invest in the company. It is the initial investment that would boost your business.
- Control: How much of the company do you want to control? Based on what you want, and the other factors considered as well, choose the best business structure for your small business.
- Taxes: Taxes are significant for every business, and you need to see how much tax you can pay for the company you set up. So, choose the business structure that suits you.
- Permits, licenses, and regulations: You will also need to see all the requirements that you need to fulfill to start the company, including the regulations, permits, and licenses.
Finally, the best business structure would be based entirely on what you want out of your new venture. Using all these factors, you will be able to make your choice.
Once you have decided and choose the business structure for your small business, it would be time to register it. That is where IncParadise can help you. In fact, we also help you in choosing the best business structure for your company. And when we will assist you in registering it with the government. Our team will support you all through the process ensuring all the legal aspects of starting a business are taken care of perfectly well. To know more or to start your company today!