Running your own business as an entrepreneur can be an exciting and fulfilling venture. At the same time, the prospect of being your own boss can feel rife with challenges and confusion, and even scary because of legal complexities. Therefore, in order to ensure that the longevity of your business is protected while your individual liabilities are minimized, it’s necessary to do your due diligence about varied business structures and figure out which one is right for you.
A Comprehensive Guide to Business Structures
When making a decision about the structure of your business, consider these options: Sole Proprietorships, Partnerships, Limited Liability Companies (LLCs), and Corporations.
Each business structure comes with varied pros and cons–and have different legal implications that can impact operations, liabilities, taxation, and long-term growth. In this guide, we will explore all four and provide you with the knowledge you need to make a well-informed choice.
What is a Sole Proprietorship?
A popular choice among freelancers and solopreneurs, a Sole Proprietorship is an unincorporated business that is owned and operated by a single person. Ultimately, the business and the owner are one and the same and there is no veil of separation between the personal and the professional. This means that all business debts, losses, and liabilities are the singular responsibility of the business owner.
Some pros associated with Sole Proprietorships include:
- Very minimal capital and paperwork is required upon setup.
- There is no double taxation. The business owner files and pays taxes in their own name.
- There is no need to register a Sole Proprietorship.
- No business checking account is needed.
- Non-U.S. citizens can own a Sole Proprietorship.
Of course, there are also some disadvantages, including:
- As an owner, you’re on the hook and liable for all business debts and obligations, which means that personal assets could be impacted.
- It can be challenging to attract lenders and investors as it is not a separate legal entity.
- You might face higher taxes in the form of self-employment taxes on business income–in addition to having to pay personal income tax.
- You might experience some credibility issues when trying to attract customers.
What is a Partnership?
This is a legal arrangement where two or more individuals run a business and share operational responsibilities, ownership, and profits. Additionally, they also share joint responsibility over potential losses, liabilities, and debt. Partnerships are common when there are multiple people invested in a company.
A Partnership carries the following advantages:
- They are easy to form in terms of paperwork and legalities.
- There is no need to pay corporate taxes as profits and losses are passed through to the partners.
And here are the cons:
- Like a Sole Proprietorship, a Partnership offers no personal liability protection–so the business partners are exposed to considerable risk.
- Taxes are passed through to the individual partners, which means being responsible for paying self-employment tax and personal income tax.
What is an LLC?
Likely one of the most popular business structures for entrepreneurial and small businesses, an LLC brings together aspects associated with both Partnerships and Corporations. One of the major perks associated with an LLC is that the business structure protects the company’s owners, which are called Members, and professional liabilities remain separate from personal ones.
Another noteworthy point is that LLCs are created by state statute, so the process of how to form an LLC in New York might be vastly different from launching one in California. It’s best to learn the individual requirements of your state to figure out if this structure is the best fit for you.
The LLC format also comes with other advantages, including:
- Protection against personal legal risk because personal assets stay separate from professional obligations.
- They are viewed with more professional credibility than what you experience in a Sole Proprietorship. Your business looks less like a “side hustle” and more like a legitimate enterprise.
- Ownership can be transferred–and it’s also possible to easily bring on new business partners.
- There are more opportunities to apply for and receive business loans and lines of credit.
- There is no double taxation (which is an issue with Corporations).
- It’s easier to hire employees with an LLC.
There are some cons to be aware of as well:
- Depending on the state you live in, your LLC could be subject to different regulations, such as annual filings and varied forms of record-keeping.
- Some businesses, including banks and insurance companies, cannot use this business structure.
- More setup is required and usually the initial investment in launching an LLC is higher than other types of structures.
- Unlike that of a Corporation, an LLC will not allow you to sell shares or take the business public, which could prove a challenge if you are trying to attract outside investors.
It’s also key to note that there are some particular factors to be aware of when registering an LLC, which again, vary by state. Generally speaking, the registration process involves:
- Confirming the business name is unique and hasn’t been claimed by another LLC in your state.
- Appointing a Registered Agent. (For additional insight, visit Northwest Registered Agent Review.)
- Filing a document called the Articles of Organization with the Secretary of State. This contains information related to your business name, your Registered Agent’s contact name, LLC Member details, etc.
- Pay your state’s registration fee, usually under $300.
- Claim a free Employer Identification Number from the IRS.
- Start a business bank account that is distinct from any personal accounts.
What is a Corporation?
The last business structure to discuss is the Corporation. A Corporation is governed by a Board of Directors and ownership in such an entity is determined by the selling of ownership shares. The Corporation business structure is best for larger businesses, companies seeking to scale, or when investment via stock offering is being sought out.
Some pros associated with Corporations include:
- As an owner, you benefit from limited liability protections.
- It is much easier to access capital via the sale of stock.
- The business can continue to operate no matter if ownership changes.
- There is no ambiguity about organizational structure.
- Attracting investors is easier due to perceived stability and transparency.
- Company shareholders are not liable on a personal level for debts.
Alternatively, here are the cons:
- You will experience double taxation on profits and the distribution of dividends.
- A Corporation is more complex to setup and requires ongoing maintenance to realize regulatory compliance.
- As an owner, you may lose some control because of the Board’s influence.
- There are higher initial costs to launch this kind of company when compared to other structures.
What Business Structure is Best For You?
As you move forward with launching a new business, it’s necessary to assess your own situation and your individual comfort levels with overall risk. Make sure you think about your goals related to:
- How much control you desire over the business.
- The ease of setup and initial/ongoing expenses.
- Personal and professional liability protection.
- Tax matters
- Your ability to bring on partners or transfer ownership.
Ultimately, many entrepreneurs and small business owners opt for the LLC format because of the benefits of the structure… not only to current operations but also achieving long-term business goals. As you get started, make sure you surround yourself with trusted partners and advisors, including attorneys and business consultants who have the ability to understand your objectives and steer you in the right direction.
Author Bio
Amanda E. Clark is a contributing writer to LLC University. She has appeared as a subject matter expert on panels about content and social media marketing.