How to Choose a Business Structure? - Types and Comparison

There are several types of business structures that you can choose to incorporate. These types include sole proprietorship, partnership, limited liability company, and corporation. 

Choosing the right one for your business depends on your goals, ownership, plans for future expansion and legal risk. While a sole proprietorship can work well for small businesses, most companies will register as a corporation. This article will discuss the advantages of each of these business structures.

Did You Know?

Every senior in the company must consider several factors before determining which sort of business structure is ideal for the business the company runs. It includes the business goals, industry, and the company’s culture.

Common Business Structures

To know the types of business structures, we’ve compiled the most common business structures below:

Sole Proprietorship

A sole proprietorship is an unincorporated business with one owner who is personally responsible for the debts and liabilities of the company. As the sole owner, you cannot protect your personal assets from business liabilities and debts. 

Sole proprietors often hire specialists and employees to help them with certain business tasks. The most important thing for a sole proprietor is to be legal and profitable. In this case, the legal requirements of operating a sole proprietorship are a lot less complex than those of other types of businesses.

A sole proprietorship is the easiest business structure to set up. You will need to register your business with the local government and obtain a business licence or permit. When you run a business as a sole proprietor, you are personally responsible for all debts and income taxes for the company. In case of a business failure, you cannot pay your supplier. If you fail to pay, your creditor may take your home.

Also Read: Types of Business - Different Types of Businesses One Must Know

Advantages of a Sole Proprietorship

• The business owner will have complete control of the business, and all profits are taxable. 
• The key advantages of a sole proprietorship are its simplicity and ease of establishment. It requires less investment, lower payroll requirements and less regulation than other business structures. 
• Sole proprietors have very little paperwork and compared to a corporation, they have lower liability and do not have to pay corporate taxes.
• This type of business structure is also highly flexible and offers tax benefits. 

Partnership

Partnership is a simple type of business structure. The business profits are divided among the partners based on their shares. In addition, a partnership can easily change its legal structure later, and the partners are generally not required to disclose their profits. However, a partnership has some disadvantages. 

One disadvantage is that all partners are individually liable for the business's debts. In case of unpaid bills, all partners are responsible for the debts of all other partners. Moreover, this type of business structure does not allow a shareholder's right to participate in management.

In a general partnership, two or more people participate in the business to make a profit. Although partnerships do not require much formality, more than one person should sign a partnership agreement. This agreement will spell out profit-sharing rules, ownership percentages, management rights and other specifics. However, it is important to note that only a few states permit this type of partnership.

Advantages of a Partnership 

• Working in a partnership business structure will allow you the benefit of a greater range of knowledge in different areas of your company.
• This structure takes on the financial burden for costs and capital expenditures required to run your company.
• Potential partners could bring the cash needed to the company. They could also be better strategically connected than you are.
• A potential benefit of general partnerships could be tax benefits. A general partnership does not have to pay income tax.

Limited Liability Company

Another common type of business structure is the limited liability company (LLC). This entity is a hybrid of a partnership and a corporation. It is formed by filing articles of organisation with the state's filing officer. Its operating agreement contains most of its provisions. In recent years, LLCs have emerged as the most popular type of business structure. There are several benefits of limited liability companies:

Advantages of a Liability Company

• Its tax structure is unique, as members of the company are not considered separate and equal. Members must pay self-employment taxes and contribute to Social Security and Medicare. 
• If the business owners have substantial personal assets, LLCs can be advantageous. 
• LLCs have a limited life, ideal for high-risk and medium-risk businesses. 
• Liability companies are protected from personal liability. This means that the company cannot be sued personally for the business debts of its owners. 
• Profits made by LLCs can be passed on to the owners, so they can be taxed like personal income.

Corporation

Generally, a corporation has a more complex organisational structure than other strictures. A corporation separates the operations of a business from its owners, so the tax rate is lower. 

Furthermore, corporation tax rates are lower for C corporations than they are for individual owners, so the structure is favourable to many small businesses. 

The two most common types of corporations are the C corporation and the S corporation. Corporations are different from sole proprietorships, and they have their own benefits. 

Advantages of a Corporation

• A corporation has more legal protection, including hiring lawyers and holding meetings. 
• The corporation is a separate legal entity, whereas a sole proprietor is self-represented in court. 
• A corporation has a lot more prestige than a sole proprietor, and it can raise capital by selling stock and attracting investors with dividends. 
• Corporations do not have to pay taxes on profits or losses, and they can own property.

Types of Corporations

There are several different business structures and corporations. This article discusses C corp, S corp and B corporation. Keep in mind that there are pros and cons for each type. 

• C corporations: Such corporations may have tens of thousands of shareholders; C corporations, similar to S Corporations, are taxed separately from their owners. The members must approve C Corporation shares before a transaction can be completed. This type of corporation can operate globally.
• Close corporation: A close corporation is a type of limited liability company that the shareholders of the company control. These businesses can be owned by several individuals or a single entity. However, a close corporation must be governed by special state laws, which supplement regular corporation statutes. These laws require that the corporation be organised under a specific statute, controlled by a few shareholders, and impose transfer restrictions on stock certificates.
• S corp: The S corporation's name comes from Subchapter S of the Internal Revenue Code, which governs the taxation of corporations. In many cases, S corporations can pass the income from their business directly to the owners without paying federal corporate tax. S corps owner is considered an employee of the business and only pays self-employment taxes on his or her salary - not on the company's profits. 
• B Corp: Benefit corporations, also called B Corp, is a non-profit entity that differs from C corporations in terms of purpose and transparency, accountability and purpose. However, they're similar in the way they're taxed. B corporations are motivated by profit and mission. Shareholders are accountable to the company for providing some kind of public benefit and financial gain.
• Non-profit corporation:  Generally, non-profit corporations are legal entities incorporated under state law. These laws vary by state, but most follow the Model Nonprofit Corporation Act. They are designed to serve public needs rather than private interests. They are often used to help the environment and animals and are ideal for many types of organisations.

Also Read: Business Model Meaning - What Is Business Model? Types, Importance & Advantages of Business Model

Comparing Business Structures

Now that you know what is business structure and its type, let’s compare them. Examine the common characteristics of these types of business structures. Keep in mind that the rules for ownership and liabilities, taxes and the filing requirements for each structure may differ with time.

It is recommended to consult a tax expert to discuss the specific requirements of your business. Look through the below business structure chart to know a better comparison between the business structures.

Conclusion

When choosing your organisation, be aware of the specific industry and state that you're working in. There isn't a 'one size fits all, and companies might not know the rules that apply to their particular situation. 

The models discussed here apply only to businesses that are for profit. If you've done your homework and are still unsure what business structure is best for you, This blog will help you in choosing your organisation. Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.