5 Types of Business Structures Explained

Types of Business Structures Explained

Choosing the right business structure is crucial because it affects your taxes, personal liability, and fundraising opportunities.

This guide will explain common business structures, but for personalized advice, consult a lawyer or accountant.

Sole proprietorship

The simplest business structure is the sole proprietorship, which doesn’t create a legal separation between your personal and business assets.

A sole proprietorship is ideal for self-employed individuals like personal trainers or artists selling unique items on platforms like Etsy.

Key considerations

  • Cost-effective setup: The primary expense is usually the DBA registration, costing less than $100 in most cases.
  • Simplified taxation: Sole proprietorships are "pass-through" tax entities, meaning profits and losses are reported on the owner’s personal taxes.
  • Hiring employees is possible: Being a sole proprietor doesn’t restrict hiring, but tax processes become slightly more intricate.
  • Limited ways to raise funding: Selling company stock is not an option for sole proprietorships.
  • Potential loan difficulties: Banks may hesitate to grant loans to sole proprietorships due to perceived credibility issues.
  • Full personal liability: If the business faces debt or legal issues, your personal assets are vulnerable.

Additional resources:

Should you register as a sole proprietorship?

– How sole proprietorships are taxed

Partnerships

A partnership involves two or more individuals sharing ownership and responsibility for a business. Partnerships can take various forms, such as general partnerships and limited partnerships.

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Partnerships are suited for individuals who want to start a business together and leverage complementary skills and knowledge.

Key considerations

  • Partnership agreement: It’s advisable to have a partnership agreement, reviewed by legal counsel, to clarify roles, responsibilities, and ownership.
  • Tax implications: Partnerships are "pass-through" entities, meaning profits and losses are directly passed to the partners.
  • Additional costs: Drafting a partnership agreement may require legal expenses.
  • Trust in partnership: Choose a trustworthy partner to avoid future conflicts and ensure shared responsibility.

Additional resources:

– How to create a business partnership agreement

– How partnerships are taxed

Plan for changes with a buy-sell agreement

– How to find the right business partner

– Traits to look for in a business partner

How many partners should you have?

What to do when your business partner is your life partner

Limited liability company

An LLC combines the advantages of a partnership or sole proprietorship with limited liability protection, similar to a corporation.

An LLC is ideal for those concerned about personal liability and operating in a lawsuit-prone industry.

Key considerations

  • Complexity: Establishing an LLC is more intricate than other business structures.
  • Tax benefits: LLCs maintain "pass-through" tax status, meaning you’re taxed only on your share of the profits.
  • Single-member LLCs: Some states allow single-person LLCs as an alternative to sole proprietorships.

Additional resources:

– How to form a limited liability company

– How to create an LLC operating agreement

– LLC costs and fees explained

– How LLCs are taxed

Corporations

Corporations offer more protection for personal assets but come with more complex legal and tax requirements.

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Corporations can be C corporations, S corporations, or benefit corporations (B corps).

Key considerations

  • Liability: Corporations provide the most protection for personal assets.
  • Capital raising: The ability to sell stock enhances investment potential.
  • Taxation: Corporate taxes are separate, but the structure may result in double taxation.
  • Complexity: Establishing a corporation requires more paperwork and formalities.

Additional resources:

How to form a corporation

– How to create an LLC operating agreement

– How corporations are taxed

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