Business Structures and Ownership Models
Choosing the correct business structure is essential for your small business plan. This decision will not only increase your chances of success, but it will also protect you legally and financially. With every business structure comes differences in personal liability, taxes, ownership, and your everyday business operations. There are many types of small businesses, and the various types of business structures and of business ownership models can either be advantageous or detrimental to how you want your company to run. Understanding the different types of business structures can help you know which is right for you in determining the future course of your company.
Table of Contents
- 1 Sole Proprietorship
- 2 LLC: Limited Liability Company
- 3 DBA: Doing Business As
- 4 Types of Business Partnerships
- 5 Types of Corporations
- 6 Co-Ops: Cooperative Businesses
A sole proprietorship business structure means that you are the one and only owner of your business. Because of this, a sole proprietorship may be suitable for small business owners, entrepreneurs, and freelancers — as starting your business is virtually effortless and straightforward. Simply register your name (it may be fictitious, such as Moe’s Movers), acquire the necessary licenses, and you are qualified to operate. Taxation is also transparent, as your income only goes to one owner, so it is up to you to independently report income, losses, and expenses.
As a sole proprietorship owner, your business entity and personal life will begin to share the same space and time. Many sole proprietors choose not to separate their personal from their professional finances. This merging of funds may be convenient initially, however, it also means that your business debts are your personal debts as well. For instance, if your business is sued, you may end up paying with your own money or personal assets.
A sole proprietorship may be attractive to small business owners for the inexpensive setup, straightforward taxation, and the fact that you are the sole owner. However, you are responsible for all debts, and this alone can make many small business owners want to expand into a more formal business structure such as a limited liability company.
LLC: Limited Liability Company
Limited liability companies apply to entrepreneurs and small to medium business owners because they provide the liability protection of a corporation, minus the complex administration. One to three individuals can own an LLC, and are be taxed accordingly. For instance, if you are the only owner of an LLC, you will be taxed as a sole proprietor. You also have the choice to be taxed as a partnership or a corporation.
Owners of an LLC are also not personally liable for business obligations, as your business entity is separate from your personal life. An LLC, however, is more expensive to set up than a sole proprietorship or partnership business structures. Sole proprietorships and partnerships do not require registration through the state and are easier to start. However, taking the extra time and effort to register your LLC through the state can allow you and your business limited liability protection and tax benefits.
DBA: Doing Business As
A DBA, or doing business as name, is simply a name used to legally register a business so it is separate (legally, financially, and for tax purposes) from the owner. Some states or local jurisdictions may require you to register your business to protect the general public and let them know transparently who they are doing business with. For instance, you may have encountered an illegal transaction with a business “doing business as” Speedy Trucker Guys, and may not know the actual owners of the company. A DBA holds the owners of Speedy Trucker Guys accountable, as they are registered with the state.
Registering a DBA has other, legitimate business implications, and may also be used by sole proprietors, such as in the example above, as an inexpensive way to separate their personal and professional identities. It can also be used to open bank accounts and receive payments under a fictitious business name. LLCs or corporations may use a DBA to operate multiple businesses without having to form additional LLCs or corporations to do so. A DBA is not technically a business structure, but a way for owners to separate entities as well as being held accountable.
Types of Business Partnerships
A partnership can be formed when two or more individuals decide to go into business for profit together. Partnerships are less expensive and complicated to create as opposed to corporations, however, they do not offer the same tax benefits. Partnerships may require less documentation; that said, a firm agreement between partners should be established — as many decisions can be made unbeknownst to you, leading to bankruptcy, or the dissolve of your company. It is best to agree upon and document a partnership arrangement when choosing your type of the partnership business structures below.
A general partnership gives every partner equal authority over your business. As such, profits, income, and liability is distributed evenly. This also means that business earnings can be spread uniformly as well.
A general partnership is not complicated to register and startup compared to a corporation, and everyone receives the profits. On the other side of the coin, everyone also incurs the losses. However, no one partner receives more damages than the other in a general partnership.
A limited partnership needs to be registered with the state as a business entity and is more expensive to establish than a general partnership. In addition, a limited partnership consists of a single general partner having unlimited liability, while every other partner has limited liability. Partners with limited liability generally have less control of the company, but pay fewer taxes.
For companies looking for investors, a limited partnership may be the correct choice, as general partners can maintain business operation while getting the funding they need, and limited partners can leave without dissolving the business. General partners are, however, subject to all debts and liabilities, unless a limited liability partner who takes a more significant role in the company — and would therefore become a general partner.
Limited Liability Partnership
In a limited liability partnership, every owner has limited liability. No partner can be held responsible for the financial or legal oversight of their fellow partners. Closely related to a general liability partnership in which every partner has a say in the business, a limited liability partnership, on the other hand, gives more protection for each partner in the event of a bad business decision on behalf of a single partner.
Types of Corporations
A corporation acts as a single entity, authorized to operate legally as a person, on behalf of the shareholders who own it. Because of the many people that could potentially get involved, corporations are very complex. There are also several types of corporations. You will need to register your corporation accordingly depending on your business’s purpose, how income will be taxed, the number of shareholders and stock issued to them, and whether your organization will be incorporated to make a profit or not.
S corporations can have no more than 100 shareholders. This business structure carries tax benefits, with just one level of federal tax to pay. There is no corporate or double taxation with this structure. In an S corporation, profits and losses are passed through all the shareholders, meaning that there is no personal liability for company debts. It should be noted that S corporations are more expensive to start up and contain limits on issuing stock.
A C corporation does not hold its shareholders subject to personal liability for company debts, even though owners will face double taxation. This means that owners will have to pay corporate tax returns as well as personal shareholder taxes. Different from an S corporation, a C corporation assigns control to one person who runs all business operations.
Your corporate structure may take that of a B corporation, aka a “benefit corporation”, if the scope of your company is to provide any public benefit while making a profit. B corporations differ from other corporations in that the shareholders drive the company with charitable actions, but still exist for profit.
Just a few shareholders generally oversee close corporations. Stocks cannot be sold to new shareholders before offered to existing ones first. Close corporations also provide limited liability protection.
In a nonprofit organization, the organization uses its income to further the efforts of its mission. Instead of dividing the profits among the shareholders, a nonprofit organization collects tax exemption, with all revenue going back into the organization.
Co-Ops: Cooperative Businesses
Cooperative businesses are owned by those who the company will benefit from. Revenue generated by a co-op is divided amongst those who operate it, also called user-owners. Members can purchase shares of the company and vote on the future of the company, although their shares do not affect the power of their vote.
Determining which type of business structure is best for your small business is a monumental decision. In some instances, and as you expand, you may end up blending specific business structures to fit your small business needs. In any case, any major business decision should not be taken lightly, and you should consult with an advisor, attorney, or accountant before making your decision.
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This post was updated February 28, 2019. It was originally published January 24, 2019.