Starting a business is all about taking things one step at a time. One big step you’ll take is determining your business structure. But, this is a step you need to take ever so cautiously. Before you take the leap and make a business structure decision for your company, get to know the various entities like the back of your hand—and the pros and cons of each.
Comparing The Types Of Business Structures
If you’re just starting your entrepreneurial journey, you may have no clue (or maybe a vague understanding) about what types of business structures you have to choose from. So, let’s break them down, shall we? Without further ado ladies and gentlemen, here are the five business entities you can choose from.
Do you enjoy doing things solo? What about having complete control over tasks? If so, a sole proprietorship may be the way to go when choosing a business structure.
A sole proprietorship is the most common type of business entity. Don’t believe me? A whopping 73% of businesses in the U.S. are sole proprietorships. That’s almost three out of every four businesses, folks.
So, what exactly is a sole proprietorship? A sole proprietorship is exactly what it sounds like: a business owned and operated by one person. Sole proprietors are liable for the company’s liabilities, debt, and losses. Therefore, if your business goes into debt, you may risk losing personal assets.
Sole proprietorships have pass-through taxation. With pass-through taxation, taxes pass through the business and onto another entity, like the sole proprietor. Basically, the business can avoid directly paying the tax, and income is only taxed once.
Pros and cons: So, what’re some pros and cons of a sole proprietorship? A sole proprietorship is relatively easy and inexpensive to form, gives you more control over your business, and generally makes the tax filing process easier. On the other hand, it can be difficult to raise capital and expand as a sole proprietor. Not to mention, you must take on more responsibility and be 100% liable for business debts and obligations.
If you like the idea of teaming up with someone for your business venture, you may want to consider going the partnership route. With a partnership, you own and operate the business with at least one other person.
There are a few types of partnerships to choose from:
- General partnership: Company owned by two or more individuals who agree to run the business as partners or co-owners.
- Limited partnership: Has at least one general and one limited partner. Limited partners only serve as investors for the partnership.
- Limited liability partnership: Partnership where owners aren’t held personally responsible for the business’s debts or other partners’ actions.
- LLC partnership: Can have two or more owners, called members. Members’ personal assets are protected.
Like sole proprietorships, partnerships also enjoy pass-through taxation.
Pros and cons: With a partnership, you have an extra set of hands, less paperwork to stress about when starting up, additional knowledge, and a reduced financial burden. However, you do risk potential conflict, have less independence, and must divvy up profits.
At some point or another, you’ve probably heard the term “corporation.” But, what exactly does it mean? Well, a corporation is owned by one or more people and is separate from its owners. This means a corporation is treated as an independent legal entity.
Corporations have the strongest protection from personal liability (which is a major perk). But unlike other structures, corporations are double-taxed. With double taxation, you pay income taxes twice on the same source of income. When it comes to corporations, the company is taxed as a business entity, and each shareholder’s personal income is taxed.
Corporations also require extensive recordkeeping and reporting requirements. So, you have to be willing to comply with more regulations and tax requirements.
Pros and cons: On the upside, corporations have limited liability, flexibility when distributing income, and essentially a virtually unlimited lifespan. Some downsides include double taxation, additional paperwork, and more expenses to establish the corporation.
Another type of corporation is an S Corp. An S corporation is owned by one or more people. With an S Corp, profits and losses are passed through directly to the owner’s personal income without being subject to corporate tax rates.
In an S Corp, only the owners (aka shareholders) of the business are taxed. If you want to avoid double taxation but still want to have a corporation, consider operating as an S corporation.
An S Corp is only taxed at the personal level, but shareholders are not personally liable for the S Corp’s losses.
S Corps must first register as a corporation and elect S Corp status using Form 2553.
Pros and cons: So, what are the advantages and disadvantages of choosing to be an S Corp? For starters, shareholders and management get limited liability. Shareholders can also receive a salary and dividends. Not to mention, you don’t have to deal with double taxation like you do with a regular corporation. When it comes to cons, there are more requirements for forming an S Corp, you must pay ongoing fees, and there’s limited ownership (no more than 100 shareholders allowed).
Limited Liability Company
A limited liability company, or LLC, lets you take advantage of a mixture of different structures. It has sole proprietorship, corporation, and partnership aspects.
LLCs are owned by one or more members. With a limited liability company, business and personal liabilities are separate. Owners are not responsible for the business’s debts. And, all owners have shared tax responsibilities.
Like many other structures, LLCs generally have pass-through taxation (unless it’s an LLC that elects to be treated as a corporation). An LLC gives you liability protection—without having to worry about double taxation.
Pros and cons: LLCs are generally easy to establish, have no limits when it comes to the number of members, and have limited liability (i.e., members aren’t personally liable for business debts). But, it’s not all sunshine and rainbows with an LLC. You also have to file additional tax forms, can’t issue stock, and can have a limited life (must dissolve or reform if an owner joins or leaves).
Choosing a Business Structure
Now that you’ve had your crash course on business structures, let’s take a look at how to choose the ideal structure for your company.
Like with anything, you should consider a few factors before choosing a structure for your startup.
With so many structures to choose from, it can be difficult to narrow down what’s best for your business. To help determine the perfect structure, consider the following:
- Level of control: Are you the only owner? Or, are you going to own the business with someone else?
- Taxation: Will the structure have pass-through or double taxation?
- Limited liability protection: Do you want your personal assets protected if your company can’t afford to pay its debts?
- Costs: What kinds of costs and fees do you have to pay to structure your business?
- Forms and deadlines: Which forms does your structure need to file? When are business taxes due?
Before making any business structure decisions, weigh the pros and cons of each and compare each entity and do your homework beforehand. After all, determining your business structure is a big decision.
If you wind up choosing a structure and not liking it, you could potentially switch structures down the road (e.g., elect S Corp status after starting a corporation).