When you're forming a small business with another person, you can choose from various types of partnership and corporation structures. The main difference between a corporation and partnership lies in whether members are separate from the business structure or have personal accountability. Other differences between a corporation and partnership include the ease of formation, taxation, fundraising options and life span of the company. Understand the benefits and drawbacks of both business structures to decide on the best fit for you.
Basics of a Partnership
Forming a partnership is an option when you have at least two people who will manage the company together and play a role in daily decision making. This form of business puts all partners in charge of ownership, profits and liabilities, and each partner pays regular individual income taxes on his earnings. Usually, the partners will agree on how much of the company each will own, and partners share all the good and bad that may come with the business.
You'll often find that businesses such as doctor's offices, law offices, dental offices and small accounting firms often use the partnership structure. However, the format can also work for manufacturers, retail stores and other businesses. The key is that all business partners need to feel comfortable with the lack of personal separation that comes with this business format. Often, partners seek liability insurance to reduce the risk.
This type of business structure means that the company dissolves when any partner leaves or if the government takes some action to dissolve the business. Partnerships can also have a scheduled end date about which all members have agreed. Partners can use a statement of dissolution to end the business. Any leftover assets will distribute according to terms of the partnership agreement or proportionally.
Types of Partnerships
The three most common types of partnerships you'll find include:
- General partnership: This is the simplest type of partnership to form since you don't need to file with the state or pay fees beyond that for a permit or business license. Each person has unlimited liability with this form, but liabilities must have a mutual agreement.
- Limited liability partnership: Available only for professional services businesses as defined by the state, this partnership type features protection of personal assets. So, partners don't need to worry about having to use their personal funds or lose their property to pay for business debts. However, the partners will still have full liability for any malpractice.
- Limited partnership: Usually requiring state registration, this structure features both general and limited partners. Unlike a general partner, any limited partner can only lose up to the amount she invested and actually doesn't help manage the business. You'll find this form more common for short-term businesses.
Basics of a Corporation
While a partnership comes with at least some personal liability, a corporation provides a clear separation between the company and its owners. So, the corporation itself has rights, and others can come after the corporation directly for legal or financial issues. The corporation structure also comes with responsibilities like keeping track of records, having shareholder meetings and filing reports.
Individuals obtain shares in the corporation for their desired percentage of ownership, and owners get dividends in return for their investment. However, these owners often don't directly manage the company and will seek other professionals to do so. Taxation typically applies at the corporate level, and owners will also need to pay personal income taxes on earnings they may receive.
Since a corporation won't dissolve when something happens to one or more shareholders, it can live on indefinitely and is thus fully independent. However, filing an article of dissolution can formally end the company if all shareholders sign an agreement. The government can also choose to end the company for reasons such as unpaid taxes. When a corporation dissolves, the shareholders usually get a share of the leftover assets after all debts and taxes get paid.
Types of Corporations
Six common corporation types for small businesses include:
- Limited liability company: Suitable for one or many owners, this structure is similar to a partnership in how the members rather than the corporation will pay income taxes. It also comes with the benefit of owners not having personal liability for the company's debts.
- B corporation: Double taxed like a C corporation, a B corporation typically makes shareholders accountable for the financial performance of the business as well as some type of public benefit the company provides.
- C corporation: This business structure has no limit on the number of shareholders and doesn't require that shareholders be U.S. residents or citizens. The corporation is taxed as well as the individuals involved.
- S corporation: With this type of corporation, you can have up to 100 shareholders as long as they're either U.S. citizens or residents. It allows individuals and certain entities like estates and trusts, but the corporation is limited to one stock class. It also requires proportional distribution of the company's losses and profits.
- Nonprofit corporation: Often used for charities, educational agencies and other organizations fulfilling a public purpose, this corporation comes with the benefit of tax exemption.
- Closely held corporation: This option can work for small companies that don't sell stock to the public. You'll usually also have no board of directors with this form.
Corporation vs. Partnership: Benefits
Forming a corporation gives you the benefit of only having limited liability as a shareholder as well as the possibility of the business surviving for future generations. You can also find it easier to raise capital since corporations can sell bonds or stock to attract more investors. For public corporations, it's especially easier to get rid of your shares if you no longer want a stake in the business, and if you form an S corporation, you get the benefit of pass-through taxation.
When you start a partnership, you get the advantage of having at least one business partner who can help provide financial resources and expertise and assist with daily business tasks. When you compare a sole proprietorship vs. a partnership, a partnership makes it easier to lighten your workload or take time off since you're not doing it all alone. Partnerships also tend to be easier to form in terms of paperwork and state requirements, and taxes tend to be simpler.
Corporation vs. Partnership: Disadvantages
When comparing a corporation vs. partnership, you'll notice that corporations come with more complexity when it comes to completing the incorporation process, filing taxes and managing the business independently. State requirements can mean putting a lot of time and money into completing paperwork and paying filing fees to get started. Except for S corporations, double taxation can apply and especially hurt larger companies. You'll also need to observe formalities like maintaining corporate records, designating a board of directors and having regular meetings.
A partnership comes with the risks involved with needing to share decision making and potentially having interpersonal conflicts. Your business partner might make a decision that harms the company, and if you can no longer handle conflicts with the partner, you may find that you need to dissolve the partnership. Partnerships also come with having to share profits with other partners and facing at least some personal financial risk since there's no separation like there is with a corporation. You'll also need to pay individual tax rates that can run higher.
- Patriot: The Pros and Cons of a Partnership
- FindLaw: Pros and Cons: Why Form a Corporation?
- Lumen: Corporations
- Wolters Kluwer: Compare Types of Partnerships: LP, LLP, GP
- HG.org: Understanding the Differences Between Corporations, LLC's, and Partnerships
- Fundera: Partnership vs. Corporation: Key Differences and How to Choose
- U.S. Small Business Administration: Choose a Business Structure