When someone decides to start a business, she should consider the legal form the organization will take. The type of business affects the organization both in the short term, in how much time and effort the owners must take to get the firm legally recognized, and in the long term by potentially setting limits on the overall size to which the organization can grow. Several types or structures of small businesses exist, each with distinctive features that best fit a given company depending on the general industry within which it operates, and the particular organizational structure in which it executes its business strategy.
Often considered the simplest type of business, one person owns and operates the firm. He owns the assets and runs the day-to-day operations. He also takes responsibility for any debts or liabilities incurred. Legally and financially, the person is the business.
In a General Partnership, the people are the business, much like Sole Proprietorships: unless agreed otherwise, each person equally shares the profits and losses, assets and costs, debts and liabilities, and also divides responsibility for the day-to-day operations and management decisions to run the firm.
One exception is the Limited Liability Partnership (LLP), often described as a ‘silent’ partner. The limited partner cannot be held responsible for any debts or liabilities incurred by the other partners, but neither can she share in managerial command of the company: her interest and exposure is limited by the amount she invests in the company.
A standard or ‘C’ corporation ('C' as in subsection C of the IRS Code) is recognized by law to be its own legal entity, standing alone from the persons who own and/or operate it. It pays for its costs and debts from its revenue, holds on to its profits, and is responsible for its liabilities. It can form partnerships with other entities, either other persons or other corporations. The owners purchase shares rather than give money or assets directly to the corporation, and use intermediary managers such as a board of directors to oversee management decisions and daily operations. For taxation purposes, a corporation pays taxes on its income as an entity; income passed to shareholders through dividends (or when a shareholder relinquishes ownership by selling stock) on profits gets taxed again. Due to the complexity of this model, most small businesses do not form as C corporations.
A corporation model that may work for smaller companies is the sub-chapter S corporation (once again from the IRS code), a stand-alone entity that bypasses the double taxation problem by passing its revenue directly to shareholders, who absorb losses as well as profits and reports the resulting income on their personal income taxes. An S corporation has a legal limit of 100 shareholders and it cannot include partnerships or corporations as part of this shareholder base.
Limited Liability Company
The LLC is another favorite small-business type as it blends the liability protection of a corporation with the simplified tax structure of a partnership. Owners, called ‘members,’ can either manage daily operations or appoint managers, and are protected from liability incurred by the business. Furthermore, they can either let the LLC be taxed like a corporation or (more typically) pass the revenue directly to its members. Unlike S corporations, other corporations or partnerships can be members of an LLC.