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Launching a business goes beyond creating the perfect idea. Many processes are involved before you can put your venture on the market. Before anything else, you must take the crucial first step of understanding and choosing your business structure.
A business structure is a company’s legal state or representation in a particular jurisdiction. Generally, it will define a company’s activities and obligations, including daily operations, tax owed, paperwork required, personal liability, and capital funds.
Owners must determine their structure before registering their company with the local, state, or federal governments. Carefully determining the structure is critical because making a mistake could lead to many legal repercussions.
Today, there are five main models you can choose from. Read below to determine which one fits your enterprise.
Sole Proprietorship
A sole proprietorship, also called sole trader, is an unincorporated business with one owner who profits from the venture and handles all the finances. It’s one of the most common structures for entrepreneurs because it’s the simplest to set up. Owners can even launch their ventures under their name because they’re not separated from their company. That means there’s no need to create a different entity name.
This structure is ideal for business owners looking for a low-risk way to test their ideas. It is helpful before establishing a formal venture by transitioning to a limited liability company (LLC) or corporation. Meanwhile, some sole proprietors prefer to retain their structures because they don’t plan to expand and acquire more people.
As mentioned, sole proprietors are responsible for their venture’s financials. Because the business isn’t a separate entity, owners must include its earnings in their income tax returns, making tax reporting easier. Plus, no state or federal government will subject them to public disclosures, like filing annual reports, since they’re considered self-employed individuals instead of corporations.
Partnership
A partnership is a structure where two or more people own and operate the business. Much like a sole proprietorship, this simple structure is a testing ground for multi-owner companies or organizations before transitioning into a formal entity.
There are two common types of partnerships: general and limited. A general partnership is where all parties share legal, operational, and financial responsibilities and liabilities. That means profits, debts, and losses are shared equally.
Meanwhile, a limited liability partnership (LLP) is a business arrangement that limits a partner’s liability in the venture. If one partner is sued for malpractice or any similar legal action, the assets of other members are safe from any liability. This partnership type is common among professionals like accountants, lawyers, and architects.
On the other hand, there are limited partnerships (LP). This partnership is a hybrid of general and limited liability partnerships, wherein one member must at least be a general partner, and another must be a silent partner.
In a partnership structure, members don’t have to pay tax on the venture’s income. Instead, the profits and losses must pass through each partner’s personal income tax returns.
Limited Liability Company (LLC)
The LLC is a hybrid business structure that combines the many advantages of partnerships and corporations. It’s one of the best options for business owners wanting a safe and easy way to launch their venture, involving straightforward processes and regulations that vary per state.
This structure is ideal for entrepreneurs with medium to high-risk businesses. However, they’re also a perfect alternative for those wanting to launch a startup. Since many types of LLCs are available, it’s no surprise that aspiring entrepreneurs prefer to create an LLC more when launching their ventures.
An LLC is also considered an independent entity. That means owners are not personally liable for any debts or lawsuits filed against the company and can protect their assets from legal obligations.
As mentioned above, an LLC is considered a “pass-through” entity. Instead of paying corporate taxes, the venture’s income and expenses can pass through the owner’s tax returns because they’re considered self-employed.
Moreover, an LLC can have unlimited shareholders, with each member having complete control of the operations if they choose so, giving LLCs a more flexible management structure than corporations. However, unlike corporations, LLCs can decide how to divide their profits and losses among members.
C Corporation
A C corporation is categorized as a separate legal entity from its owners. Generally, it possesses many rights as an individual, including entering contracts, loaning and borrowing money, and filing and receiving lawsuits.
Because corporations are independent entities, owners are not liable for any legal actions or obligations their businesses face. That means their assets, like houses, cars, and savings accounts, are protected if the venture fails.
The best part about C corps is that they base ownership on the percentage of stock held. Because of that, they can run without disruption, even if a partner leaves or sells their shares. Corporations can also raise funds by selling company stock and offering shares as employee benefits. It also allows unlimited shareholders.
Meanwhile, owners must pay tax separately from their venture’s earnings, leading to double taxation. However, corporations can deduct certain benefits they provide to employees. These include health insurance, retirement plans, and other related expenses.
Aside from C corp, other corporations are benefit, closed, open, and nonprofit. Aside from the advantages mentioned above, these businesses are tax-exempt because they generally operate to help others. There’s also the S corp, which will be discussed below.
S Corporation
An S corporation or S corp is a business structure with special permission under the tax code to pass its taxable income, credits, deductions, and losses directly to its owners. That means they can pass through their owner’s tax return, avoiding double taxation.
The S corp is available to small businesses with 100 or fewer shareholders. It’s considered an alternative to the limited liability company (LLC), another structure also considered a “pass-through” entity.
With this structure, shareholders are not personally responsible for any of the venture’s debts and liabilities, allowing them to protect their personal assets. They can also sell their shares without any tax consequences. Like a C corp, the business can function even when losing a shareholder.
Choose Your Structure Wisely
Identifying the proper business structure can be challenging. The key is to take time and analyze the options mentioned above. Consider how much control and flexibility you want over your business. Plus, consider factors like capital investment, liability, and taxes. Once you have the proper structure based on such factors, you can clearly understand how to build and run your venture.
