Starting a business can be exciting. Most entrepreneurs brainstorm ideas, make plans and experiment with marketing strategies. Before getting started, it's important to choose a business structure that supports your goals. There are several types of business organization and each has unique characteristics.
TL;DR (Too Long; Didn't Read)
Depending on your needs, you can register a sole proprietorship, an LLC, a partnership or a corporation.
Forms of Business Organization
One of the first things you need to consider when starting a business is how it should be structured. Choosing the right legal structure will make it easier to achieve compliance and grow your revenue. This decision will influence how much you have to pay in tax.
Take the time to compare the different kinds of business. Consider your short- and long-term goals. Let's say you provide web design services remotely. In this case, you might want to register a sole proprietorship. However, if you're planning to expand your business and hire people in the near future, an LLC would be a better choice.
Each type of business structure is subject to different legal requirements. The costs vary too. Registering a corporation, for instance, is more complicated and expensive than forming an LLC. A sole proprietorship has low startup costs and minimum legal requirements. The downside is that its owner will be fully responsible for its debts and obligations. Research your options before making a decision. Determine which of the following types of business organization best suits your needs:
- Sole proprietorship
- Limited liability company
- Limited liability partnership
- Limited partnership
- General partnership
Understanding the advantages and disadvantages of each business structure is crucial to your success. This decision will have long-term implications for your revenue, expenses and personal liability. Consider the nature of your business, its vulnerability to lawsuits and the level of control you want to have.
No two types of business organization are the same. Each comes with different tax consequences and involves more or less paperwork. If you're just getting started, it may be worth discussing your options with an attorney or a tax adviser.
About Sole Proprietorship
The number of sole proprietorships is rapidly growing in the U.S. According to the IRS, no other sector has experienced such a large increase since 1988. In 2015, sole proprietorships generated a total profit of approximately $331.8 billion. This type of business is easy to set up and gives you full control over your revenue. Likewise, it's easy to dissolve. Additionally, you have to file fewer forms compared to other types of business organizations.
A sole proprietor is fully responsible for all profits, losses, liabilities and assets. He will pay personal income tax on profits. Since you're putting your personal assets at risk, this legal structure is not ideal for high-risk businesses. If you get sued or accumulate debt, you might end up losing your home and other personal belongings.
Additionally, sole proprietorships often find it difficult to raise funds or attract investors. Most times, their owners are limited to using funds from consumer loans or personal savings. If you ever decide to hire employees, you may not be able to attract top talent. This legal structure works best for those who run a one-person business, such as copywriters, photographers, artists or web developers.
About Limited Liability Companies
A limited liability company is one of the most popular forms of business organization. Unlike sole proprietorships, it protects your personal belongings from financial liability. This type of business can have one or more owners and allows for a flexible distribution of earnings among members. Compared to corporations, it involves less paperwork and lower startup costs.
However, its owners can still be held personally responsible for debt and liabilities if they engage in fraudulent activities. Furthermore, certain types of businesses cannot be LLCs , such as charities, insurance companies and banking institutions. Another drawback of forming a limited liability company is that you may be required to pay franchise or capital values tax in most states. Additionally, this business model involves high renewal fees.
Types of Business Partnership
If you have a friend or colleague who shares your vision, you may want to form a partnership. This type of legal structure involves two or more people who decide to go into business together. Famous entrepreneurs such as Steve Wozniak and Steve Jobs started as business partners.
There are three main types of partnership: limited partnerships, limited liability partnerships and general partnerships. This business structure is relatively easy to set up but involves slightly higher costs compared to a sole proprietorship. The liability, risks and management are shared among its owners. In general, partnerships are a preferred choice for small- and medium-sized businesses, such as law firms, marketing agencies and real estate companies. In a general partnership, all owners are involved in the decision-making process and can be held liable for business debts. A limited partnership, on the other hand, may include both general and limited partners. The general partner will have more control over the company and faces greater liability.
The biggest advantage of forming a partnership is that you can share responsibilities with the other partner. Plus, you can brainstorm ideas and combine your skills to expand the business into new markets. Joining forces with other professionals opens the door to more opportunities and allows you to provide a wide range of service. The downside is that your business may fail if disagreements arise. Since you'll be sharing the profits and losses, conflict is bound to happen. Another drawback is that you will be required to fill out more paperwork than you would when forming an LLC or a sole proprietorship.
Start Your Own Corporation
Corporations are some of the most common forms of business organization. Approximately 22 percent of small businesses in the U.S. are using this legal structure. A corporation is a legal entity of its own. Therefore, its owners have limits on their personal liability. Shareholders can transfer ownership by selling stock.
This business structure involves the most paperwork and the highest operational costs. Accounting, tax and record-keeping requirements are more stringent compared to those associated with other legal entities. However, some taxes may be lower for a corporation. Additionally, it's easier to raise capital than it might be with an LLC, for example.
Corporations are strictly regulated and must have written bylaws. This document describes the management structure as well as the rights, responsibilities and liabilities of the company's directors and officers. How much you will pay in tax depends on the type of incorporation. A C corporation, for instance, is subject to double taxation, meaning that its dividends are taxed at the shareholders' level and its profits at the corporate level.
A major benefit of incorporating your business is that you'll enjoy greater flexibility compared to other legal structures. It's relatively easy to transfer ownership to your children, bring in new partners and add shareholders. If you wish to avoid double taxation, you may opt for an S corporation. In this case, you will not be allowed to bring in more than 100 shareholders. Additionally, this business model provides less flexibility than a C corporation.
As you can see, there are various kinds of business and each has its advantages and drawbacks. Furthermore, each serves a specific purpose. Consult a tax adviser or a business consultant to gain better insight and make the right decision.
- IRS: Sole Proprietorship Returns, Tax Year 2015
- Entrepreneur: Sole Proprietorship
- NerdWallet: LLC: Pros and Cons of a Limited Liability Company
- The Balance Small Business: 7 Steps to Starting Your Own Corporation
- Community Tool Box: Writing Bylaws
- Santa Clara University My Own Business Institute: Business Organization
- IRS: S Corporations