Starting a business is an exciting venture, and choosing the right business structure is an important step. The business structure you choose will influence everything from day-to-day operations to taxes and how much of your personal assets are at risk. Be sure to choose a business structure that gives you the right balance of legal protections and benefits.
Common Types of Business Structures
Here, we will review the general definitions, advantages, and possible disadvantages of five common types of business structures. Do remember that rules and requirements can vary by state.
Sole Proprietorship
A sole proprietorship is owned by one person and is best suited for a small business owner who can afford the financial exposure. The U.S. Small Business Administration adds, “Sole proprietorships can be a good choice for low-risk businesses and owners who want to test their business idea before forming a more formal business.”
Advantages of Sole Proprietorship:
- Simple to establish and maintain.
- Personal tax only (business income is included in the owner’s personal tax return).
Disadvantages of Sole Proprietorship:
- No differentiation (or protection) between personal and business assets.
- Unlimited personal liability.
Partnership
A partnership is owned by two or more people and is best suited for complementary owners who want the benefits of a sole proprietorship but want to share the responsibility and the risk. According to the SBA, “Partnerships can be a good choice for businesses with multiple owners, professional groups (like attorneys), and groups who want to test their business idea before forming a more formal business.”
Advantages of Partnership:
- Similar advantages as sole proprietorship.
- Liability and risk now shared among partners.
Disadvantages of Partnership:
- Individual control of the business is limited.
- While risk and liability are shared among partners, so are control and direction.
Limited Liability Company (LLC)
An LLC is owned by one or more people and is best suited for owners who want asset protection similar to that of a corporation, but without the corporate taxes. From the SBA, “LLCs can be a good choice for medium- or higher-risk businesses, owners with significant personal assets they want protected, and owners who want to pay a lower tax rate than they would with a corporation.”
Advantages of an LLC:
- Differentiation and protection between personal and business assets.
Disadvantages of an LLC:
- Not available in all states.
C Corp
A C Corp (or simply, Corporation) is owned by one or more people and is well suited for a business’s long-term growth while offering its owner(s) the strongest protection from liability. According to the SBA, “Corporations can be a good choice for medium- or higher-risk businesses, those that need to raise money, and businesses that plan to “go public” or eventually be sold.”
Advantages of a C Corp:
- Strongest personal protection.
- Ability to raise money through sale of stocks.
Disadvantages of a C Corp:
- More expensive to establish, and require more extensive record-keeping, operational processes, and reporting.
- Can be taxed twice: first when the company makes a profit, and again when dividends are paid to shareholders (on their personal tax returns).
S Corp
An S Corp (short for S corporation) is owned by one or more people, but no more than 100, and all must be U.S. citizens. This is a special type of corporation that is designed to offer the liability protections of a corporation without the double taxation, but there are restrictions involved. From the SBA, “S Corps can be a good choice for a business that would otherwise be a C Corp, but meets the criteria to file as an S Corp.”
Advantages of an S Corp:
- Profits, and some losses, may be passed through directly to the owners’ personal income without being subject to corporate tax rates.
- Liability protection like that of a C Corp.
Disadvantages of an S Corp:
- Not all states handle S Corps the same way, and some don’t recognize S Corps at all (treating them as a C Corp instead).
- There are special limits on S Corps (such as no more than 100 shareholders, and all must be U.S. citizens).
While this information is meant to help as you consider your business structure options, be sure to seek out the advice of a professional for your specific situation. With over 25 years of experience working with business owners, if you are considering starting or buying a business, we would love to talk to you. Contact us today for more information.