By understanding the different types of business structures, you can make a more informed decision as to which type of business you choose to form.
With the right structure, you can not only decrease your personal liability and lower your tax burden, but stay compliant to all the relevant laws and regulations as well as receive access to certain types of funding.
To help you select the right type of structure for your business, here’s a closer look at the 3 most common business types:
Sole proprietorships
With this type of business structure, you will be the only person responsible for managing the company along with any debts it might incur, and if you haven’t formed a legal structure and conduct business as a contractor or a freelancer, you’re classed as a sole proprietor in the eyes of the law. Sole proprietorships are not separate legal entities from their owners, and any relevant permit laws must be adhered to and the necessary licenses obtained.
Operating as a sole proprietorship has a number of benefits:
- You can combine your business and personal assets
- This business structure is relatively inexpensive to operate
- Any income earned can be offset by your income along with any losses you take on
- You have total authority over all choices that impact your business
However, it’s just as important to recognize that a sole proprietorship has its disadvantages, too, just as all business structures do:
- As the owner, you are not permitted to sell an equity stake to raise capital
- Any debt accrued by the business is the owners responsibility alone
Partnerships
Formed when two or more individuals start a company with the intention of making a profit, a partnership doesn’t require a legal document to start it, but it’s recommended to have one to give better protection to all involved parties.
There are a few advantages to starting a partnership, namely:
- They are simple to set up
- Hiring employees is easier as new staff members can be offered a share of the company
- As a pass-through entity, taxation on a partnership is simplified – with each partner paying taxes in accordance with the amount they receive in distributions
As with sole proprietorships, choosing this type of business structure isn’t without its disadvantages:
- Each partner is responsible for the debts and liabilities of the business
- Profits made must be shared among the partners
- Each partner is also responsible for the actions of the other partners, which can be problematic
Limited liability partnerships
When some individuals form a partnership, they opt to incorporate themselves as limited liability companies, or LLCs, which reduces their individual risk as they’re not responsible for the actions of the other partners, and they become members, rather than partners.
Many entrepreneurs find this business structure to be particularly advantageous as swapping from a regular partnership to an LLC, doesn’t have any significant impact on the company’s daily activities.
Some of the advantages of this business structure are:
- Personal liability protection means that the LLC owners aren’t responsible for any business debts or lawsuits the business may incur
- Owners also have limited liability, meaning they’re not responsible for debts or lawsuits incurred by the business beyond their personal investment
- Simplified taxes
Some of the disadvantages include:
- Double taxation of profits
- Additional costs that make it an expensive structure compared to others
To help you make a clear and informed decision about which business structure to choose, liaise with an entity management firm who can simplify the process and help you get started.