There are many options when choosing the best business structure to maximize your company’s success. The following are the most common business entities along with the advantages and disadvantages to each. It is important to take legal considerations into account, and understand the differences between business structures when choosing the best business entity for you.
Sole Proprietorship
A Sole Proprietorship is a business owned by a single person. In terms of legality, there is no distinction between the business and the owner of the business.
Sole Proprietorships allow the owner to obtain full control of business, therefore the owner is entitled to all profits generated from the company. With this, the owner must pay personal income tax on these profits.
Sole Proprietorships are (1) easy and the (2) cheapest to establish. (3) They only require a single taxation and no corporate income taxes. These advantages are the reason why they are
popular among small business owners and self-contractors.
Although the owner is entitled to all profits, the owner is also responsible for all liabilities, losses and incurred debt. So, if the company faces financial issues and a creditor files a
lawsuit against the company, the owner will have to pay incurred debts out of
pocket. Sole Proprietorships are overall disadvantageous in their (1) unlimited
liability in business obligations and debts,(2) limited lifetime of the company by the life of
the owner, and (3) difficulty in transfer ownership of the company.
If the advantages outweigh these disadvantages, and your business has a chance of a small liability, a Sole Proprietorship may be the best entity for you.
As a Sole Proprietorship, it is common for business owners to register as a DBA, or “Doing Business as” and operate under an alternative name as opposed to the owner’s name. Instead of operating as Alejandro Rioja, you can operate as Flux Ventures. If you are interested in DBA filing services, LegalZoom is able to assist in the process.
Partnerships:
A Partnership is a business owned by two or more people via signed formal agreement among the the partners. Partnerships can be divided into two categories: (1) general partnerships and
(2) limited partnerships.
General Partnership (GP)
In a general partnership, each partner is embedded in the business, and each partner participates in business management and control of the business operations.
Similar to Sole Proprietorships, general partnerships are (1) easy to establish, and (2) require a single taxation. The difference compared to a Sole Proprietorships is that you will split the control and ownership among all partners. The partners are entitled to the profits and the costs are split among the partners. Any partner can be sued for all business debt incurred.
Similar to the disadvantages of Sole proprietorships, general partnerships have (1) unlimited liability for all owners in business obligations and debts, a limited lifetime for the company
and a difficult process to transfer ownership.
Limited partnerships
Limited Partnerships are a variation of a General partnerships, they consist of at least one general partner and additional limited partners. Limited partnerships require at least one partner be a general partner and the limited partners to refrain from contributing to the management of the business.
Limited partners are not as embedded in their business as general partners are. Partly because limited partners are limited to the amount of cash they have contributed to this business.
While general partners unlimited liability for all debt and obligations, (1) limited partners are limited to the contribution they have made to business.
While a general partnership is has the lifetime according the general partner’s life, (2) limited partners are allowed to sell their interest in their business.
What’s the point of a limited partner? In terms of equity in the entrepreneur’s eyes, since it is difficult to raise funding for partnerships, investors can purchase a limited partnership
interest and become these limited partners.
As a limited partner, there are advantages and disadvantages to being a part of a partnership. The advantages are that if you run into financial issues, the worst that can happen is founders lost their initial investment. However, Limited Partners do not have complete authority over the company. Their involvement is minimal so entrepreneurs generally do not prefer this form of business entity. It does not guarantee protection of control and authority of the business.
Corporation
A corporation is a distinct legal entity that is separate from its owners. A corporation has the right to:
(1) enter into contracts
(2) loan and borrow
money
(3) acquire and
exchange property
(4) sue and be sued
(5) hire employees
(6) own assets
Corporations consist of
(1) shareholders
(2) directors
(3) management team
The shareholders control the direction of the business and the policy the company abides by. These shareholders elect the board of directors who then assign the managers.
Compared to the business entities that define a sole proprietorship and a partnership, the main distinction of a corporation is that the owners are separate from the management team.
Advantages of a corporation include: (1) a limited liability to the businesses debts and obligations, (2) an unlimited lifetime, corporations are not dependent on the owner’s lifetime and (3) lack of difficulty in transferring ownership.
However, (1) corporations are difficult to establish and are more complicated than starting a sole proprietorship or a partnership. (2) Incorporators are required to abide by bylaws. Another major disadvantage to a corporation is (3) double taxation. In addition to personal tax income, federal government tax corporate income.
Limited Liability Corporations LLC
LLC are common
An LLC is a comparably new form of business entity, and in some ways, a hybrid between a partnership and corporation. The goal of an LLC is to function and be taxed like a partnership (exempting from corporate tax)while simultaneously achieve limited liability to obligations and business debts. This form of business entity separates your personal finances and the businesses’ finances, providing a structure which allows for protection from liability.
Learn more about the advantages and disadvantages of an LLC:
S Corporations and C Corporations
Under two categories that fall under corporations, S – Corporations and C – Corporations, each have different legal structure.
Under Subchapter S (S Corporations), Internal Revenue Code requirements must be met. This gives the company less corporation benefits, however it allows the company to (1) be taxed as a partnership, avoiding double taxation. Additionally, owners of the S Corporation (2) enjoy other corporate benefits and (3) are able to pass income, credits and any deductions to their shareholders.
Under a C Corporation, (1) owners are able to limit their financial and legal liabilities. Profits are taxed similar to sole proprietorships, (2) the owner must pay personal income tax on these profits.
Conclusion
When deciding on which business entity to represent your company, you should consider the advantages and disadvantages of each and gage which your business would benefit the greatest from. There is no answer to which is the best, however depending on the size and income of your business, you can start deciding which legal structure is best for your business.
