Starting a new business is an exciting time. It can also be a very stressful time. There are a lot of things that you need to decide in the early days of your business to set you up for success down the road.
Chief among these decisions is the type of legal structure that you choose for your business. This is a huge choice. It directly affects:
- How much you’ll pay in taxes
- The paperwork requirements for your business
- How you can raise money
- Your personal liability for debts
This choice isn’t something that should be taken lightly. It’s a huge decision.
Still, every business is different and the legal business structure that you choose will depend on your own needs and goals. What works for another business may not necessarily work for you, even if you are similar in what you offer.
You must educate yourself on the different options that are available to you. The more that you know and understand about the different types of corporate structures, the better decision you will make for your business.
In this article, we’ll provide an overview of the different types of corporate structures. We’ll go over what they are, what kind of businesses typically utilize them, and provide details that can help you to make the right decision for the future of your business.
Important Company Structure Type Considerations
As you begin looking into the different company structure types that you can choose for your business, there are a few important questions you need to ask yourself to make sure that you are going into your evaluation prepared and put yourself in a position to make the right choice.
Here are a few questions that you should ask yourself before you begin your search.
- How much revenue do you expect to make? An important consideration for tax purposes. Higher revenue levels can benefit from more advanced company structures.
- Do you plan to hire employees? Now are in the future. Some company structure types, like a sole proprietorship, do not enable you to hire traditional employees.
- What are your plans for growth? Do you want to stay small? Grow quickly? Certain organization structures will put you in a better position for growth moving forward.
- What risk are you exposed to? More advanced types of company structures offer liability protection. That means that your personal assets can not be seized if you were found liable for specific damages. For instance, a car mechanic would have a high-risk factor if their work did not hold up and caused someone to be injured.
- What state are you in? While most company structure types are similar between states, there may be some nuances in your home state that you should know about before opening the company.
The type of company structure that you use is a critical decision and it’s important that you know the answers to these and other questions before you begin your search.
Now let’s dive into the specific types of company structures.
Sole Proprietorship
A sole proprietorship is the simplest of the business structures and is the most common form of business structure used in the U.S. In a sole proprietorship, the owner of the business has complete and total control over the company.
They are typically formed in home-based or solo-entrepreneur type of businesses. They are also common in one-man shops, retail businesses, and consulting firms. In sole proprietorships, the owner is responsible for keeping track of their own records and paying full self-employment taxes every year.
The downside of this company structure type is that the owner of the business receives no liability protection. They can be held personally responsible for their company’s debts and financial obligations. This is a problem for anyone that operates in an industry where they could potentially cause damage.
A landscaping business, for instance, is a common business that uses a sole proprietorship. However, in the process of landscaping a clients yard, what would you do if you burst a water main and were sued by the client or the city for damages? Under a sole proprietorship, you would be held completely responsible for all damages, where in other company structure types you would have some liability protections and only the business would be liable — not your personal assets.
In short, a sole proprietorship is a simple but effective way to quickly start a business and begin legally accepting money for services or goods. It is, however, the company structure type that provides the least amount of protection to the owner, which is something that anyone starting a new company should take into consideration.
Partnership
Partnerships, as the name would imply, are typically formed when two or more people partner together to run a business. Each partner has an equal share in the profits and losses of the business and a perfect pay and ownership balance must be maintained financially.
There are some similarities to a sole proprietorship. Each partner is required to report their income on their personal tax return and pay a self-employment tax to the IRS. They also do not receive the liability protections that some of the more advanced business types offer.
Partnerships can be formed through oral agreements and handshakes, however, written agreements are a much better choice in most cases so that disputes and lawsuits between partners have some initial groundwork laid responsibility and ownership within the partnership.
In short, if you have a business partner that will equally share in the success of your company, a partnership may be the right choice if the company will remain small or only feature the two of you. If you plan on hiring employees, partnerships may not be the best choice in the long-term.
Limited Liability Company
Limited liability companies (LLCs) are one of the newer company structure types. They are meant to function as a solid option between sole proprietorships and more complicated business structures like S corps and C corps.
An LLC provides liability protection to the owner of the company, but are referred to as “members” under the structure. They provide the same protections from liability and obligations under similar corporations. Unlike other company structure types, they can be set up to be managed in a way that is very similar to a partnership.
Additionally, there are tax considerations. The way that an LLC is taxed depends on its own internal company structure. Certain business types are not allowed to use the LLC structure, including banks and insurance companies.
An LLC is a popular choice for solo entrepreneurs and small business owners that want the agility of a sole proprietorship, but want to retain liability protections for their personal assets. Although this company structure type is new, it has quickly become the most popular type of non-sole proprietorship business type for small businesses and companies.
Corporations
Corporations are a more complex type of organization structure. This structure completely separates the liabilities and obligations that the company incurs from the responsibility of the owners. In industries with a high level of risk, corporations are often the smart choice.
Corporation business structures are regulated by the laws of the state in which they are headquartered. They differ from sole proprietorships and partnerships in that they are taxed as completely separate entities at corporate tax rates — not the self-employment tax rate that other company structure types require you to pay — which can mean more or less revenue toward taxes depending on a number of factors.
There are two types of corporation structures — S corporations and C corporations. Each type has different tax rules. C corporations are the most standard type of corporation. S corporations can pass income and losses onto their shareholders while avoiding paying federal income taxes to prevent double taxation of their corporate profits. You would likely only consider registering an S corporation if you were planning on issuing or selling shares in your company. Another huge benefit of the corporation structure is the ability to raise money. Yes, you can sell stock. But you can also raise funds in other ways as well.
Corporation regulations are specific to the state they reside in. Likely, you’ll need help from an attorney that specializes in this area to guide you in your decision-making process. A corporation must follow a set of complex rules and regulations and failing to meet the requirements can lead to fines that can be debilitating.
Speak with Experts
While it is an excellent idea to educate yourself on the different company structure types, making this decision on your own can be a tough choice. If you make the wrong decision, it can be difficult to undo all of the ramifications that come with it.
Before signing on the dotted line, you should speak with a business structure expert (or small business attorney) about the options that you have available to you. With their expertise and your understanding of the business that you intend to run, you can put yourself in a position to make the right choice, set your company up for growth, and limit the number of issues that you have to deal with down the line from making the wrong choice.
Choosing the Right Company Structure Type for Your Business
When you select a business structure, there are a few things that you need to take into account. Legal liability, taxes, cost, flexibility, your plans for the future of your business — these are all serious considerations when it comes to choosing your company structure types.
Ultimately, it is always a good idea to speak with a small business attorney to help guide you through the process and understand the specific considerations as they apply to your state.
The tips in this article are meant to guide you in your initial research and help you to have a basic understanding of the different company structure types.
Once you have your company structure in place, we invite you to use Organimi to set up your organizational chart and gain a top-down view of how your organization will be internally structured.