Business structure types: here’s everything you need to know
How to choose the right business structure for your service business
How to choose the right business structure for your service business
Understanding the ins and outs of business structure types is an important step in your entrepreneurial journey. Leveraging the right business structure (aka “business entity”) can have a positive impact on growth, taxation, funding, and your personal liability as a business owner.
To help you choose the best legal structure for your business, let's dive into the pros and cons of every option and examine the types of companies that typically benefit from each business structure type.
A business structure is an organization formed by a single person or group to conduct business. Choosing the right business structure is a big deal, as it influences how you form, manage, and grow your business.
The business structure that you choose will directly impact:
The most commonly used business structures are:
Keep reading to understand the pros and cons of each structure and learn which businesses they suit best.
A sole proprietorship is the most common type of business structure and the easiest one to form. A Sole Proprietorship is not considered a separate structure, but an extension of a single owner. In the eyes of the law, you and your business are one and the same. All business-related activities from profit, employees, to liabilities, are attached to the sole proprietor. The only way a Sole Proprietorship can be owned by two people is when those two people are a legally married couple who file joint taxes.
Sole proprietorships are typically best for people who want to start a small business with the intention of running it solo. A sole proprietorship is usually a popular option for personal trainers, makeup artists, writers, and home-cleaning services.
Partnerships are similar to sole proprietorships in many ways. The main difference is that the business has two or more owners. There are three kinds of partnerships: general partnerships (GPs), limited partnerships (LPs), and limited liability partnerships (LLPs).
In a general partnership (GP), all partners actively manage the business and share in the profits and losses. This is the default mode of ownership for multiple-owner businesses, and there’s no need to register a general partnership with the state; when two or more people go into business together with the goal of earning a profit, a general partnership exists by default.
A limited partnership (LP) is like a general partnership with the addition of having limited partners. In a limited partnership, there will always have to be at least one general partner who has unlimited liability in the business and a limited partner who has limited liabilities. Like a general partnership, it’s important to have a partnership agreement with a detailed division of contributions, duties, profits, and losses in the business. Typically, general partners are more involved in the business's day-to-day operations, while limited partners take a backseat and usually just contribute capital.
Limited liability partnerships (LLPs) allow some or all of the partners the benefit of having limited liability. These partnerships, however, can only be entered into by licensed professionals of certain industries. Only some states recognize LLPs. And in most of those cases, only lawyers, accountants, and architects are permitted to form limited liability partnerships. Before you move ahead with this business structure, remember that states have different rules and regulations so it is important to check the rules in your area.
General partnerships and limited partnerships are a good choice for those looking for an easy and cost-effective way to start a business with multiple people. It is a good way to minimize the risk and cost of starting a business because more than one person will be taking on these responsibilities. A general partnership is a good option for bands, tattoo artists, or any business that wants to be started by more than one person.
Licensed professionals from certain industries should form a limited liability partnership if they have a group of fellow professionals who will find it beneficial to form a business together. A good example would be a law firm of attorneys with different specializations. A law firm that is an LLP can attract a bigger number of clients because they offer more than one specialization.
A corporation is a business structure that is legally separate from its owners. Shareholders, therefore, are not liable for the corporation’s debts and liabilities. Although forming a corporation has the benefit of being a separate structure from the shareholders, there are some disadvantages as well.
For example, forming a corporation requires more paperwork and admin. A corporation must follow the article of incorporation bylaws, must hold shareholder and board meetings, and prepare minutes of those meetings. If the bylaws are not followed, the corporation risks the limited liability protection of the shareholders.
A C corporation is the traditional and default type of corporation, wherein there can be any number of shareholders, the corporation pays its own taxes and the shareholders receive dividends that they need to pay taxes on.
An S corporation on the other hand can only have a maximum of 100 shareholders, one class of stock available, and all shareholders must be US citizens or residents. The biggest benefit of an S corporation, especially for small businesses, is that an S corporation is only taxed once, at the level of the business owners or shareholders.
A corporation is often best for those looking to start a long-standing business with plans for high growth and expansion. Incorporated businesses can also gain credibility in the eyes of investors and consumers, tax rates can be lower, and financing and grants will likely be easier to obtain compared to other business entities. If you’re interested in incorporation, talk to a licensed professional to discuss the best option for your business.
A limited liability company (LLC) is a hybrid business structure for private companies that combines the aspects of a partnership and a corporation. An LLC benefits from the flexibility and pass-through taxation of a partnership while maintaining the limited liability of a corporation. Owners, known as “members” in LLCs, can opt for the business’s profits, losses, credits, or deductions to be processed on their tax returns, just like in sole proprietorships, partnerships, and S corporations. Or they can elect to be taxed like C corporations.
LLCs can be advantageous for entrepreneurs who want to have an easier-to-manage business structure that comes with the added perk of limited personal liability. Typically, an LLC is a popular choice for newer operations that are still figuring out what business structure best suits their business.
So what’s the best business structure for your business? Unfortunately, there’s no one-size-fits-all answer to this question. Ultimately, working with an attorney is the best way to determine which legal structure makes the most sense for your business.
Before you book in with a pro, ask yourself the following questions:
Yes, it is possible to change business structure types. Many service businesses begin as sole proprietorships or partnerships, and incorporate when it makes sense to do so. Switching can be a tedious process, but it is generally straightforward. Just be prepared to deal with the paperwork and be sure to outsource the process to a licensed pro.
Pass-through taxation (also known as flow-through taxation) is a way of taxing a business structure by allowing the taxable income from business operations to “pass through” from the business to the owner(s). Both sole proprietorships and partnerships use pass-through taxation, and the owners of these business types pay all business taxes on their personal tax returns (i.e. there are no additional tax forms for the business itself).
Double taxation is when income tax is paid twice on the same income. For example, an incorporated business will pay income taxes on profits. And then shareholders will also have to pay personal income tax for that same income they receive as dividends from the business.
Not always. Depending on the amount of income and allowable deductions, personal income tax rates alone may still be higher than corporate tax rates plus income tax rates combined. Working with a CPA is the best way to know whether incorporating—and taking on double taxation—is the right move for your business.
A B corporation (aka “B corp”) is not an official type of Corporation, but a special certification awarded to businesses that go above and beyond to meet specific high standards of operation. For businesses to be certified B-Corporations, they must meet the following criteria:
There are several benefits to being a certified B-corp company. The most beneficial thing is that it brings positive awareness to your business. Aggregate awareness of B Corps in the US is 43% and in Canada it's 32%, and there's been a 488% increase in news attention given to B Corps in 2020 compared to 2019. Popular companies that are B-corp certified are Nespresso, The Body Shop, and Patagonia.
Want to get your B corporation certification? Visit the Guide to B corporation certification for processing fees and requirements.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult their own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Durable assumes no liability for actions taken in reliance upon the information contained herein.
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