Starting a business requires making crucial business decisions. And one of the critical ones you’ll need to make is selecting your company’s legal structure.
Why is that so? Your choice will significantly influence every aspect of your business, from taxation and liability to ownership and day-to-day operations.
In this post, we explore the common types of business structures, their pros and cons, and the business each suits, enabling you to make an informed decision.
#1. Sole proprietorship
A sole proprietorship is the easiest to set up, making it the go-to option for many individuals. In this structure, you have maximum control over all aspects of the business. If you run a business but do not register as any other entity, you are considered a sole proprietorship.
Pros
- It is the easiest to form
- You have complete control over the business
- It has low operating costs
- Simplified taxation as business income is reported on your personal tax return
- Easy to dissolve
Cons
- You are personally responsible for all the debts and liabilities of the business, putting your personal assets at risk.
- Difficult to raise funds as you can’t sell stocks or get a loan from a bank
Who is it for?
Freelancers, home-based businesses, and low-risk businesses requiring little capital and having no employees. Also ideal for individuals who want to test their ideas.
#2. Partnership
In a partnership, you and someone else or other people can come together to start a business. Generally, individuals in a partnership contribute to the business equally and split profits and losses evenly. However, there are other partnership types with varying levels of liability protection.
Pros
- Also easy to set up
- Partners share decision-making, responsibility, and resources, such as skills and finances.
- Simple taxation (pass-through) in which business income is reported on partners’ individual tax returns.
- Low operating costs
- It is easy to dissolve
Cons
Each partner is personally responsible for all debts and legal issues that arise, except there’s liability protection
Disagreements and conflicts can easily arise among partners
Who is it for?
Partnership is best for individuals who do not mind sharing financial burdens and decision-making. It is commonly found in law firms, medical practices, and firms offering professional services.
#3. Limited Liability Company (LLC)
A limited liability company (LLC) is a hybrid structure that combines the stand-out benefits of a sole proprietorship or partnership and a corporation. LLC offers protection from personal liability and enables business income and expenses to pass through to the owners’ tax returns.
Pros
- Offers protection of personal assets from business liabilities.
- You or other members can manage it or appoint managers.
- You can file business taxes on your personal tax.
Cons
- More expensive to set up and operate than a sole proprietorship or partnership
- Requires formal documentation
- Tax filings and obligations can vary from state to state
Who is it for?
If you want the tax simplicity of a sole proprietorship/partnership and the liability protection a corporation offers, an LLC is for you.
#4. Corporation
Sometimes called an S or C corp, a corporation is a legal entity separate from its owners. This means a corporation can have legal and liability issues, and its earnings can be taxed.
Pros
- The personal assets of shareholders are protected from business debts and obligations.
- It is easy to sell stock to raise capital and attract investors, providing growth opportunities.
- Ownership or shareholders can change, enabling the continued existence of a corporation.
Cons
- Double taxation in which both the corporation and shareholders are taxed on income and dividends.
- It can be complex and expensive to set up and manage.
Who is it for?
It is ideal for large and established companies intending to raise funds by selling ownership shares to shareholders. International businesses will also benefit from the structured legal framework of a corporation.
Which business structure should I choose?
Now you know the different business structures and their pros and cons. However, it’s best to contact a legal expert to assess your specific circumstances, understand your objectives, and guide you in choosing the right structure that provides the right foundation for success. Give us a call today.