Starting a business can be both an exciting and exhausting process. On one hand, you’re finally realizing your dream of owning your own business. On the other hand, there are so many processes and measures to put in place that it can become all too easy to forget one of the most crucial things when planning to start your own business – your business structure.
For most people, this is typically a hard choice between choosing to structure the company to function as a corporation or a limited liability company. For others, it’s choosing whether to operate a sole proprietorship structure or as a partnership. While these may seem like easy-to-make decisions, certain things need to be considered before choosing your business structure.
In this article, you’ll find some useful tips from experts to guide you in choosing the right business structure. Let’s get right into it!
What Are The Types Of Business Structures?
There are four main types of business structures. These are:
- Sole Proprietorship
- Limited Liability Company (LLC)
I’ll discuss each of these business structures in the successive sections. However, you should note that each type of business structure provides different benefits. Now, let’s delve a little into the various types of business structures, shall we?
A sole proprietorship is a business structure where a business is managed by one business owner. In this case, the individual is directly responsible for making every decision concerning the business and he/she is also liable for the business. In a sole proprietorship, there is no distinct difference between the business and the business owner, as such, the business is not legally recognized as a separate entity.
The registration process for a sole proprietorship is relatively easy and inexpensive. The business owner simply needs to choose a business name and file as a DBA or “doing business as” for tax and sales purposes.
Typical examples of sole proprietorship businesses include home-based businesses, freelance services, or small startups.
As the name suggests, a partnership involves two or more people owning a business together. There are different types of partnerships, these include:
This is the cheapest and easiest type of partnership to set up. In this type of partnership, the partners divide the responsibilities, costs as well as profit according to the agreement.
In a limited partnership, the liability is distributed based on who the controlling partner is. The general partner typically gets most of the liability while investors and other partners get limited liability in the business.
Limited Liability Partnership (LLP)
Ah – I know what you’re thinking. “Isn’t a Limited liability partnership (LLP) the same as a limited partnership?” The answer is no. In LPP, all partners have limited liability and can have management roles, unlike in a limited partnership where one partner has unlimited liability, and the others have limited liability, and as a result, cannot have management roles.
Limited Liability Company (LLC)
Even if you are unfamiliar with the term, there’s a good chance that you’ve heard or read the term “LLC” somewhere. LLC, otherwise known as Limited Liability Company, is a merger between a partnership and a corporation. A business operating as an LLC is typically owned by “members” rather than partners. Legally, there is a clear distinction between the business and the members, meaning business assets and personal assets are legally separated.
Of course, there are different types of corporations, but the main types are C Corporations and S corporations. I’ll briefly discuss both types next.
A C-corp is legally considered as a separate entity from its members and owners. This type of corporation offers the highest level of protection from personal liability. In this type of business structure, the income taxes are paid off of the profits, although it also comes with double taxation. Compared to other business structures, a corporation can easily attract investors.
Unlike C-Corps, an S-Corp is designed to have a maximum of 100 shareholders, all of which must be U.S citizens. This business structure is designed to avoid the double, which is an advantage S-Corps have over C-Corps.
How To Choose The Right Structure For Your Business?
Choosing the right business structure can be quite overwhelming, especially with so many options to choose from. It’s quite normal to have no idea which business structure would work best for your business. However, there are certain factors to consider that can help you figure out the right structure for your business.
Experts suggest that you should choose a business structure based on these factors:
- The size of your business size;
- Your daily operations and;
- Your long-term goals,
Of course, it’s alright if you don’t get it on the first try. You can change or update your business structure as your business grows. The truth is that as your business evolves, there will most likely be a need to change your business structure to suit your business requirements.
That said, let’s get into the top tips for choosing the right business structure.
Consider Your Tax Situation
Before choosing a business structure, it is best to consider your tax liability. This is because the type of business structure you adopt will determine how your business will be taxed. For instance, if you choose to operate your business as a sole proprietorship, you will be legally considered as the business’s sole owner.
From a tax perspective, this might not be a great idea because your income and your business income will be considered the same. As such, you will have to report your company’s losses and profit when you file your personal income tax return.
An excellent alternative is finding one or two business partners and operating your company as a partnership. While you may still be required to report your profits and losses on your personal income tax return, your profits and tax burden are split between you and the other owner(s). If you are unsure of which business structure to choose, you may need to seek the help of a business advisor or an accountant to make the process easier for you.
You need to investigate the extent to which your business needs to be protected from legal liabilities before choosing a business structure. If you decide to act as a sole proprietorship, you might not incur a lot of costs, but you will be directly responsible for any incurred losses. Even worse, If your business goes under, you risk losing your personal assets (e.g., your car or your home) to cover them.
If you’d rather not take this risk, choosing to act as a limited liability company or a corporation may be the best option for you. In both cases, only the business’s assets are at risk if the company has unpaid debts. Choosing to act as a partnership may also not be an excellent choice because you and your business partners might be directly responsible for any losses incurred by the business.
This is probably one of the most important factors to consider when choosing the right business structure. You want to be sure that you choose a structure that’ll make raising money for your business easy. Generating sufficient capital to operate as a sole proprietorship may be a lot more challenging than raising money for a corporation. It is very unlikely that investors will want to put their money into sole proprietorships. However, corporations typically attract investors, as such, it is very easy to access funding as a corporation.
Getting loans as a sole proprietor can also be difficult since sole proprietorship comes with unlimited personal liability. So, if your priority is raising money as quickly as possible, then it would be best if you considered operating as a corporation.
Think About How Challenging The Starting Process Will Be
Each business structure comes with different degrees of complexity, especially at the starting process. While raising money to start a corporation is relatively easy, a corporation is very expensive to start and requires a lot of money to keep the business running. Apart from the high costs of operation, starting a corporation often requires more paperwork than any other type of business structure. To put it simply, there’s literally more stress when it comes to starting corporations than sole proprietorships and partnerships.
Unlike corporations, sole proprietors are relatively easier to start and require less money to keep the business going. If you are not up for the stress, opting for sole proprietorship or partnership may be the best option for your business.
How do you want to run your business? Do you want sole authority when it comes to making all the decisions? Do you want all the profits made? Then the best business structure for you is the sole proprietorship. On the other hand, if you want more control over your business, you might want to opt for an LLC.
I get it, starting a business can be a very overwhelming process, but don’t forget to compare various business structures as you develop the plan for your business. While making the ultimate choice of business structure might not be as easy as expected, getting professional help from a business advisor or an accountant can make the entire process quicker and easier.