When it comes to career choices, there’s nothing more exciting than starting a new business. Whether you’re striking out on your own or teaming up with a group of friends, turning a good idea into a successful business is an amazing feeling. However, before you can secure the bag as the CEO of your own company, you have a few decisions to make. One of the most important is choosing the best structure for your business.
There are four types of for-profit business structures:
- Sole Proprietorships
- Partnerships
- Limited Liability Companies (LLCs)
- Corporations
Each of these business structures has its own relative advantages and disadvantages. Depending on your circumstances one or two of these may be a good fit for your next business venture. But, determining which one is the best fit requires planning. Here’s a brief introduction to the four major business structures to help you get started.
Sole Proprietorships
The simplest business structure is a sole proprietorship. Sole proprietorships are unincorporated businesses that are owned and operated by one individual. This means there is no legal distinction between the business owner and the business. In other words, the owner is the business. The business cannot be sold, and if the owner dies the business no longer exists. A sole proprietor can hire employees. But a sole proprietor does not have the option to take on a business partner or an investor.
Advantages
The advantage of starting a business as a sole proprietor is simplicity. Creating and dissolving a sole proprietorship is simple because there are no required forms or fees. Filing taxes is also simple because the business does not file a separate tax return. Instead, the owner reports profits on the their individual tax return. Furthermore, there are no formal requirements regarding how the business must be managed. All of these facts give sole proprietors tons of flexibility when it comes to operating their business.
Disadvantages
On the flip-side, sole proprietorships offer limited growth potential. Unlike other business structures, a sole proprietor cannot bring on investors or business partners without creating a separate entity. This limits the business’s ability to raise capital, which in turn limits its ability to develop. Another disadvantage is that a sole proprietorship provides no personal liability protection. The business owner is personally liable for the business’s debts. This means the owner’s personal assets are at stake if the business is sued or becomes insolvent.
Best For…
In the end, people who work alone as independent contractors and people interested in testing a product or service before offering it to a wider audience should consider a sole proprietorship. This is because setting up the business is easy, and it is simple to dissolve if the owner decides to go in a different direction.
General Partnerships
There are several types of business partnerships. The most basic is a general partnership, which is when two or more people (or entities) agree to engage in a for-profit venture with one another. The partners put together a partnership agreement, which lays out the rights and responsibilities of each partner. This agreement also sets out how the business will operate, and under what circumstances the business will come to an end.
Advantages
Like a sole proprietorship, a general partnership provides simplicity and flexibility. Its formation and termination does not require the filing of any forms. In addition, the business partners get to decide exactly how the partnership will operate, and what duties and responsibilities they owe to one another. Like a sole proprietorship, a general partnership is not a separate legal entity from the owners. Therefore, it does not file its own tax return. Having a partners typically also means more available resources for the business.
Disadvantages
The downside to a general partnership is similar to a sole proprietorship. Since the business is not a separate legal entity, shares of ownership cannot be sold to raise funds. Furthermore, general partners do not have personal liability protection. Therefore, owners/partners are personally responsible for the business’s debts. If the business goes under or gets sued, the owners’ personal assets may be on the line.
Best For…
A general partnership is best for people or businesses who are interested in working together to pursue an opportunity, but who don’t necessarily want to combine their businesses. Consider, for example, a small record label looking to get their artists’ music to a wider audience. They may partner with a larger record label to gain access to their distribution channels. In exchange for providing this resource, the larger record label collects a percentage based fee. Both partners bring something to the table that the other doesn’t have access to. By partnering with each other, they are able to take advantage of an opportunity they would have missed out on. Furthermore, they do so without creating a separate business entity, which would be a larger and longer-term commitment.
Limited Liability Companies (LLCs)
The newest form of business entity is an LLC. Unlike the two structures above, an LLC is its own legal entity. That means an LLC has a separate legal existence from its owner(s). Owners can sell their share of the business, and if an owner dies the business continues to exist. Creating an LLC requires more administrative formalities than creating a partnership or sole proprietorship. The person(s) creating the LLC must follow the procedure laid out by their state, which typically includes registration and a fee.
The most important document for an LLC is the operating agreement. Every LLC has one. Operating agreements are important because they form the basis for how the business will function. They do not have to be written. However, it is a good idea to have a written operating agreement because it helps avoid and settle disputes before they become issues that could destroy a business.
Advantages
Many people choose the LLC structure because it offers the best of both worlds. Though they are not as simple to establish as sole proprietorships, LLCs are relatively easy to set up. Many vendors offer to set up LLCs for a few hundred dollars or less. Because the LLC is governed by an agreement, they also offer serious flexibility when it comes to structuring business operations.
On top of that, LLC’s provide business owners with the personal liability protection that partnerships and sole proprietorships lack. This also comes with the option to have profits taxed on the owner’s income tax return, instead of the business. This is called pass-through tax status. Finally, LLCs are able to sell a portion of the business to raise money. This allows them to take on investors.
Disadvantages
Because LLCs provide a mix of the most desired features offered by other business structures, there aren’t many disadvantages. However, that does not mean that forming an LLC comes without risk. Because they are legal entities with their own separate existence, certain formalities must be followed. Otherwise, business owners risk losing the advantages that come with having an LLC. For example, owners of an LLC should never mix the business’s funds with their own personal funds. If they do, they risk losing their personal liability protection because they are treating the LLC like a sole proprietorship or partnership.
Best For…
The LLC structure can work for just about any business. LLCs can be used for businesses with any number of owners, and in any number of industries. For many entrepreneurs, the decision comes down to a choice between forming an LLC and using another business structure. In which case, they must assess their priorities and weigh their options.
A sole proprietorship or general partnership may work better than an LLC if the goal is to take advantage of an opportunity that will only last for a limited time. However, if the goal is to grow the business, an LLC is probably a better option. An LLC is more flexible and simpler to create than a corporation. This generally makes it a better option for newer entrepreneurs unfamiliar with corporate formalities. However, if the owners hope to someday take the company public, that wouldn’t be possible while the company is an LLC.
Corporations
Like LLCs, corporations are business entities that exist separately from their owners. The primary difference is there are more formalities that must be followed. For example, corporations are required to issue shares. These share’s represent ownership, and the people who hold them (a/k/a shareholders) are the owners. Corporations are also required to have a directors that make management decisions for the company. Corporations are governed by their bylaws, which lay out how the business will operate.
Advantages
The corporate structure provides several benefits. Like an LLC, a corporation is a separate legal entity from its owners. Therefore, owners have personal liability protection as long as corporate formalities are properly followed. Corporations also have the widest range of options when it comes to raising money to support the growth of the business. Not only can shares of the business be sold to private investors, but corporations may also have the option to take their company public. A corporation can also use its structure to generate prestige and social capital by getting high profile individuals to sit on its board of directors.
Disadvantages
There are a few disadvantages to the corporate structure, most of which relate to the formalities that must be followed. Due to these formalities, properly setting up a corporation can be complex. As a result, corporations are often more expensive to establish and operate because solid legal advice is a must. Corporate formalities also make this structure less flexible than others. This is true when it comes to choosing a management structure and winding down the business. Finally, corporations are more restricted in their choice of tax treatment than LLCs.
Best For…
In the end, a corporate structure is best for companies run by experienced business people. That does not mean that new entrepreneurs should never consider creating a corporation when establishing their business. However, if they do, they should consider bringing in a seasoned business person as an investor or board member. Due to the cost and complexity of setting one up, the corporate structure should generally be reserved for businesses that already have significant assets.
Consider Your Business Structure
Aspiring entrepreneurs have a lot to consider when it comes to starting a new business. One of their primary concerns should be choosing the right business structure. The choice may be obvious. But when it is not, the wise entrepreneur takes the time to understand their options, and make the best decision based on their business goals.
In the end, building a successful business requires some planning. If you’re having a hard time figuring out where to start M. Zane {+} Associates is available to help. We can help you choose and set up the best structure for your business, so that all you have to worry about is being a boss. Give us a call at (267) 475-7052, or schedule a quick consultation to learn more about how we can empower you to reach your business dreams.