When starting a business, either a new one or reorganising an existing one, the kind of legal structure the business would operate is important for consideration by the business owner(s). The choice of business structure is a core determinant of how the daily operations of such business would be done – how much paperwork the business needs to sort; how much taxes to be paid; how much personal liability risk is incurred by the business owner and even the ability to raise money.
Although, a business owner can change to a different structure with time, it is expedient to know what different business structure entails and choose which to run, depending on business preferences, short-term and long-term goals. Converting from one business structure to another may sometimes come with restrictions in some locations and could come with tax consequences, business dissolutions, and some other unforeseen complications. Hence, it is usually on the bright side for any intending business owner to have at least, a basic grasp of what each business structure entails.
Below are the common business structures employed by many businesses, where we point out some of the merits and demerits of the different business structures:
Sole proprietorship business structure is often used by small start-up businesses because it is considered inexpensive to operate and requires a minimal amount of paperwork. It is owned by only one person and managed by the same. This structure doesn’t produce a separate business entity in the sense that the owner’s personal and business assets and liability are not separate.
- Inexpensive to form and requires less paperwork
- Owner has total control of the business
- Unlimited liability risk
- Difficult to raise capital because of perceived low credibility of business
A partnership business structure is one that comprises of two or more business owners, who jointly manages decisions, and shares taxes, profits and losses according to a partnership agreement among the partners.
There are two common kinds of partnerships:
- Limited partnership: here, there is one partner whose liability is unlimited while other partners have limited liability. The partner with unlimited liability has the most control, with others having limited control over the company. The limited liability partners pay personal taxes, but the general partner pays self-employment tax.
- Limited liability partnership: all partners have limited liability. They all share control of the company and each have a protection against partnership debt, as no partner is responsible for another partner’s action
Compared to other business structures, a corporation is more expensive to set up and requires several paperwork. It is a separate entity from its owner(s), hence, requires complying to tax regulations and other forms of regulations binding this business structure.
They are usually made up of shareholders, with the majority shareholder making most policies and decisions. Corporation offers comprehensive protection for the personal assets of the owners.
There are various kinds of corporations. This includes S Corp, B Corp, C Corp, Closed Corporation and Non-profit Corporation.
- Owners are not personally liable
- Tax documents are based on corporate tax regulations. Owners only pay tax on profit dividends paid to them
- Expensive to implement
- More regulations are involved
- Independently owned by stakeholders
Limited Liability Company LLC
An LLC combines partnership and corporation business structure.
- Personal assets are protected
- Profit or loss doesn’t face corporate tax. It passes through personal income
- Lower tax rate for owners
- Owners must pay self-employment tax
- Unintended membership dissolution and reformation in some states, as members are added or removed.