In business, there are four types of organizational structures: sole proprietorship, partnership, corporation, and limited liability company (LLC). Let’s break down how to form each type of business, what rules they must follow, and any advantages and disadvantages generally associated with each.
Most small businesses are sole proprietorships. Sole proprietorships mean that one person owns the entire business, and there is no legal separation between the business and its owner. As a result, these businesses are subject to fewer taxes and regulations than the other three types of business.
- The easiest and cheapest way to start a business
- One owner is in complete control of all business operations and decisions
- All profits are directly linked to the owner’s tax return
- Since there is no separation between the owner and business, personal assets are at risk if the company folds or accrues debt.
- Loans are limited
- It may be harder to attract big name and big business companies to work with
Unlike a sole proprietorship, two or more people own the business in a partnership. The law still does not differentiate between the company and personal assets, but it’s now split over multiple people instead of just one. Partners should agree on handling business operations, decision-making, liability, and potential profits and debts.
Partnerships can be general or limited. Partners divide and assume responsibility, liability, profits, and losses in a general partnership. In a limited partnership, partners do not equally share all duties, as some are investors who do not have operational control or liability in the matter.
- Easy to start
- There is generally more capital initially since it’s coming from multiple sources.
- All profits are directly linked to the owners’ tax returns.
- Each partner is responsible for their joint partners’ actions and decisions.
- Profits are shared between all partners.
- Partnerships can end due to the death of one partner.
Corporations separate the company from the owner(s). They must follow more rules and regulations than sole proprietors and partnerships and are subject to state taxes. Owners of corporations are known as shareholders, and they elect board members to manage company policies and make critical decisions. Corporations will continue to run if ownership changes.
There are three types of corporations: C, S, and nonprofit corporations. C corporations are taxed as business entities, meaning the owners will also see their profits taxed individually. S corporations are small business corporations that divide profits and losses equally between shareholders. Nonprofit corporations are exempt from all taxes if they do not create a profit. Most charities are nonprofit corporations that use their cash flow and profits to support their cause.
- Shareholders have limited personal liability for debts accrued by the corporation.
- Shareholders (typically) are only responsible for their share in the company.
- Corporations are the most complex, most expensive, and most time-consuming businesses to create
- Corporations are subject to and monitored by state and federal agencies
- Higher taxes are generally seen with corporations than other forms of business
Limited Liability Company (LLC)
As the name suggests, LLCs offer lower liability to owners, separating the owners’ liability from the company. LLCs are a mixture of partnerships and corporations. LLCs protect their owners’ assets, as with corporations, while there are fewer rules, regulations, and taxes, as with partnerships.
- Owners have no personal liability for debts accrued by the company
- There is a more formal structure than a sole proprietorship or partnership, but there is still great flexibility
- LLCs are only taxed once
- LLCs can be expensive to create and operate
- Loans and other investments must come from a bank
Sole proprietorship, partnership, corporation, and LLCs are the most common types of business in America today. Each type of business has advantages and disadvantages, depending on what you’re looking to get out of, and put into, your business. With experience working with each type of business, we can tell you that there is no quick or easy answer to what type of business is the right choice. Take a look at your ideas, capital, and what risks you are willing to take. These questions will help determine what type of business is right for you.