Written by Reginald Chan on April 7, 2021

Understanding the Types of Business Structures

If you’re fortunate enough to start your own business, you’ll soon discover that there are intricacies involved, especially if you want to be a long running and successful business. One of the very first decisions you will have to make when starting a business is choosing a suitable business structure that goes well with your startup. But, choosing the perfect business structure, especially if you're a newbie in the business world, can prove to be confusing. So, before you make a choice about your business structure, understand your choices and what they mean for your business.

The business structure you choose for yourself will ultimately dictate the amount of taxes you'll have to pay, the amount of paperwork, the personal liability you'll have to face, and how much money you'll be able to make.

Factors to Consider When Choosing Your Business Structure

There are some factors that you should consider when choosing a business plan for your company or startup. Whether your business is on a small or large scale, it is important that you make sure you select a business plan that gives you the most benefits.

The basic factors you should consider when looking at potential business plans can be:

  • Amount of taxes
  • Cost analysis
  • Flexibility of plan
  • The legal liability
  • The future needs for your business

Types of Business Structures

Every business structure has a different policy for tax liabilities, which affects your business a lot in the future. Some business structures dictate taxes to be paid at a personal income level. While others define a double-tax payment policy that encompasses both personal and business incomes.

There are four basic types of business structures you can choose from. It is important to learn about all types clearly before making your decision regarding the business structure so that you can end up making a decision most advantageous for you.

1.  Sole proprietorship

A sole proprietorship is the most common type of business structure, this is preferred by most people as it gives autonomy to one single person. So, if you want complete control over your business without any interference from partners or sponsors, this is the best option for you.

A sole proprietorship essentially means that you will own and operate your business. The liabilities that come with the business will be your own and business assets will be in the category of your personal liabilities.

The tax for this type of business structure includes both your business expenses and personal income. Moreover, in this type of business structure, there are certain risks you will have to take. In case your business goes into debt, or is at risk of going bankrupt, your personal assets will be the next at-risk things. Similarly, any loss in the business would be a loss in your personal income.

Another problem associated with Sole proprietorship is the difficulty in getting funding for your project or business. Usually, banks and other financing sources do not prefer giving business loans to individuals. So, for funding, you will probably have to depend on your savings or take a loan from your family.

2.  Partnership

The word partnership clearly states the sharing of the firm or business between 2 or more individuals. They own and operate the business together which makes the business have a better standpoint for survival and also flourishing. Partnerships are generally of two types

  1. General Partnership
  2. Limited Partnership
  • General Partnership

The type of partnership in which the business is owned by two or more individuals is called a general partnership. The management of the business is looked over and handled by all the partners and so are the responsibilities. In this type, partners don't look at each other like different owners of a single business rather they look at each other as co-owners and co-workers. The responsibility of the partnerships’ debts and all other obligations are looked over. In general partnerships, the partners don't just own and run it but they also have to assume liability for the partnership.

Partnerships themselves have an immense advantage which is the tax treatment. If you have a partnership formed the tax doesn't have to be paid by the partnership. It is "passed on" to the individual legal partners. This saves some money legally which cannot be done without partnership.

  • Limited Partnership

This type of partnership has partners of both types. In order to start a limited partnership, you must have one general partner and one Limited Partner. They are both essential for starting this partnership. In this type of partnership, the limited partners are just sole investors in it. Other than investments they have no business decision rights whatsoever. A general partner will have control and responsibility while the limited partner will have ownership without having to pick up the weight of any kind of risk or responsibility on their shoulder.

Both of these partnerships have their advantages and disadvantages depending upon a lot of factors and involving legal paperwork.

Unless you have a ton of passive investors limited partnership may not be the best option you have. It creates complexities and there are loads of administrative filing. However, if you have 2 or more actively participating and responsible partners then a general partnership may be the right and easy decision for you.

There is a very serious concern though regarding general partnerships which is the "personal liability". Just like the sole proprietors the general partners are also personally liable for any debt or obligation of the partnership. They may have to represent or even act as other partners on their behalf. They may have to take legal decisions on their behalf such as taking a loan or make any other decision that will affect the business.

3.  Limited Liability Company

A limited liability company is a hybrid business structure that combines the advantages of a sole proprietorship, partnership, and corporation business structures. This model has numerous benefits, it reduces tax responsibilities and the risk of losses of personal assets like in the case of a sole proprietorship.

LLC business structure provides you with a number of options. It is a highly flexible business plan that separates your personal and business liabilities. Plus, tax responsibilities are divided equally among all shareholders or partners in the company.

If you select an LLC business structure, you won't have to deal with double taxations and also get liability protection, which is the best deal. Another great thing about LLC businesses is that the owner will not be responsible if the company goes into debt, which essentially means that your personal assets will never be at risk. 

However, make sure that you know how an LLC works because this business structure like every other has some drawbacks as well. LLC business structures have a limited life such that you will have to get your agreement reformed if someone from your LLC partnership leaves, or if someone new joins in. Moreover, the tax liabilities of an LLC business structure vary with location. Every state usually has different policies of tax liabilities for an LLC business.

4.  Corporation

A corporation is treated as a separate legal entity, which is independent of a sole owner. Therefore, you cannot be the owner of a corporation but a shareholder. A corporation business structure is further divided into two types:

  • C-Corp:

A C-corporation business structure is the most basic type of corporate business structure.

This business structure has its pros and cons. For example, corporations are the best option if you want to have a high level of security, i.e., safeguard of personal liabilities, but corporations are double-taxed, i.e., you will have to pay twice the amount of tax on the same income. This can be a declining factor in favor of a corporation business structure.

However, it’s a good choice if you want to start a large-scale business or later expand your business and add shareholders. Because of the extensive record-keeping required by corporations and the strict rules and regulations, this plan will work for you if you like a disciplined environment. Although the decisions will not be solely your own, every shareholder will have a vote in important business decisions.

  • S-Corp:

A sub-type of business structure for a corporation exists, known as an S-corporation business structure. This type of structure is usually preferred by small businesses because of its fewer taxation policies.

This structure is also defined as a separate legal entity and does not have one owner, instead, the business has a number of shareholders. Unlike the policy in C-corp, S-corp is only taxed once, at a personal level. Although s-corp business structures provide liability protection, it is in a limited amount. Another drawback of this type of structure is that it is only possible in the United States.

Selecting the best type of business structure can sound intimidating at first, but once you get the hang of the different types of business structures and their benefits, your choice becomes pretty clear. Although each type provides some great benefits, each one has its own drawbacks as well. In the end, it is up to you to decide which type would best suit your circumstances and business requirements. 

Article written by Reginald Chan
A meticulous entrepreneur by nature and a serial entrepreneur. Founded a few awesome startups including Marketing Lancers, WP Maven and TheMarketingHuddle.com. Reginald is a sought-after success coach, digital marketing consultant and TEDx speaker from Asia. Currently, he teaches others how to make money online for free.

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