How to Choose Your Business Structure
Choosing your business structure is one of the most important decisions you will make as a business owner. Your business structure affects how you pay taxes, how you raise funds, how you manage risks, and how you share profits. There is no one-size-fits-all solution for every business; you need to consider your goals, preferences, and circumstances before choosing your business structure.
In this blog post, we will compare four common types of business structures: sole proprietorship, partnership, corporation, and limited liability company (LLC). We will explain what each structure entails, what are its advantages and disadvantages, and what are some examples of businesses that use each structure. By the end of this post, you will have a better understanding of how to choose your business structure.
Sole Proprietorship
A sole proprietorship is the simplest and most common type of business structure. It is an unincorporated entity that does not exist apart from its owner. A commonality (though not 100% necessary) is when your business has mainly one “worker” and that’s you - the person who owns and runs the business.
In this instance, the owner has full control over the business operations and decisions. The owner also bears all the liabilities associated with running the business, including debts, lawsuits, and taxes.
Some typical examples of businesses that use a sole proprietorship are:
Freelancers
Consultants
Photographers
Plumbers
Now there are pros and cons of operating your business as a sole proprietor! The biggest advantage is that it’s probably the cheapest and easiest way to operate.
The biggest advantages of a sole proprietorship are:
Easy and inexpensive to set up and dissolve
No legal formalities or paperwork required
No separate tax return for the business; income and expenses reported on personal tax return
Full ownership and autonomy over the business
Some disadvantages of a sole proprietorship are:
Unlimited personal liability for all business obligations
Limited access to capital, skills, knowledge, and network
Difficulty in transferring or selling the business
Lack of continuity if the owner dies or quits
Partnership
A partnership is similar to a sole proprietorship but with two or more owners instead of one. A partnership is also an unincorporated entity that does not exist apart from its owners, but the partnership is based on a detailed agreement (in writing, ideally!). The owners share responsibilities and profits according to their agreement. The owners also share liabilities associated with running the business unless they form a limited partnership or a limited liability partnership (which have specific legal setups).
Some advantages of a regular partnership are:
Easy and inexpensive to set up and dissolve
No legal formalities or paperwork required unless there is a written partnership agreement
No separate tax return for the business; income and losses passed through to personal tax returns
Greater access to capital, skills, knowledge, and network – two people may have a bigger network than just one!
Some disadvantages of a partnership are:
Shared liability among partners unless there is a limited partnership or a limited liability partnership
Potential conflicts among partners over decision-making authority or profit distribution (especially if the partnership is 50/50 – who decides if you don’t agree?)
Difficulty in transferring or selling ownership interest without consent of other partners
Lack of continuity if one partner dies or withdraws
Some examples of businesses that use a partnership are:
Law firms
Accounting firms
Medical practices
Restaurants
LLC – Limited Liability Company
An LLC is an unincorporated entity that exists separately from its owners, and is based on an official legal agreement. It’s a popular structure for many small business owners. Instead of shareholders, it has members who own and manage the business according to their agreement. A major advantage of an LLC over a sole proprietorship is that it has limited liability for its members - they are only liable for their investment in the business.
Some advantages of an LLC are:
Flexible and simple to set up and dissolve
Fewer legal formalities and paperwork required than a corporation; still requires some legal work and specific documents
No separate tax return for the business; income and losses passed through to personal tax returns
Limited liability for members; they are not personally responsible for business debts or lawsuits
More control over decision-making by members; they can choose how to run and structure their business
Some disadvantages of an LLC are:
More complex and costly to set up and dissolve than a sole proprietorship or a partnership
Potential self-employment taxes on members’ share of income
Difficulty in raising capital through issuing stocks or bonds
Lack of uniformity across states; different rules and regulations may apply depending on where the business operates
Some examples of businesses that use an LLC are: local restaurants, retail shops, investor groups that co-invest in real estate, etc. Many large corporations started off as LLCs and as they grew, converted to corporations.
Corporation
A corporation is different from a sole proprietorship or a partnership in that it is an independent legal entity that exists separately from its owners. To set up a corporation is a much bigger deal, but it has many advantages along with extra work. Typically, a corporation has shareholders who own shares in the company but do not manage its operations. A corporation often has directors who oversee its policies and strategies but do not run its day-to-day activities (there are exceptions; a small corporation often has founders that own the shares and run the company). In most cases of a large corporation, there are officers who execute its plans and actions but do not own any or many shares in it.
Some advantages of a corporation are:
Limited liability for shareholders; they are only liable for their investment in the company. This is a big deal if the company operates in a space where lawsuits can happen!
Potential tax benefits such as lower corporate tax rates or deductions
Easier access to capital through issuing stocks or bonds (which is costly but often necessary for big companies). Many venture capitalists and angel investors require a company to be a corporation for investment purposes.
Easier transferability or saleability of ownership interest through trading stocks. Note that this is not a big advantage if the company isn’t public and owned by tons of people.
Greater credibility and prestige in the market. This can be a significant advantage if the company intends to work with well-known and/or big clients.
Some disadvantages of a corporation are:
More complex and costly to set up and dissolve
More legal formalities and paperwork required such as articles of incorporation, bylaws, annual reports, etc. The startup paperwork is significant but so are the annual reporting requirements.
Separate tax return for the corporation
Double taxation on corporate income (at corporate level)and dividends (at shareholder level)
Less control over decision-making by shareholders
Potential conflicts between shareholders, directors, and officers
Some examples of businesses that use corporations are all the well known companies most people have heard of: Microsoft, Walmart, Coca-Cola, Nike, Tesla, etc.
Choosing your business structure is a crucial step in starting your own venture. You need to weigh the pros and cons of each option and consider your goals, preferences, and circumstances. There is no right or wrong answer; you need to find what works best for you!