How to Choose a Business Structure

Before you actually write a business plan or obtain your business license, you should decide on which legal structure you will use.

There are several legal structures you can choose from, and each one has its pros & cons. 

Below we will discuss the different types of legal structures and a few benefits of each one.  Remember, the legal structure that is best for your business depends on the type of business you have.

Sole Proprietorship Business Structure

The most common and simple business structure is a sole proprietorship.  This is the most common type of business within the United States.

This type of business is commonly referred to as a "mom & pop" business. This is because it is usually a very small and simple business, and it has only 1 legal owner.

The owner will typically do all of the duties necessary such as: marketing, managing, selling, etc.

Pros:

The benefits of a sole proprietorship is that it will avoid many taxes that corporations and other business structures will have to pay. There are several taxes that are directed specifically towards larger companies.

Also, this is the easiest business to start & manage. The income the business receives is included with your own income. You have no separate identity from your business. In other words, your business is you.

This is also usually the least expensive business to start. Many sole proprietorships do not have any employees. They will just "work for themselves."

Cons:

The downside to this structure of business is that you will be responsible for all liabilities personally. This means that if you get loans, accidents, or any other mishaps, you are personally and legally responsible to ensure they get paid off. This is probably the biggest disadvantage for the sole proprietor.

Another downside is capital. Larger business structures such as corporations can raise capital (money) quickly by issuing stock.

Partnership Legal Structure

A partnership is similar to a sole proprietorships, but there are 2 legal owners.  Partnerships are common among doctors, lawyers, and other professionals that go into business together. However, any type of business could theoretically have a partnership structure (and many do).

In a partnership, the partners will both generally contribute money, time, and work for the business. They will usually require a legal agreement, stating the profit/loss division, duties to be performed, etc.

Pros:

The benefits of the partnership is that the partners can divide the expenses & work together as a team. They can be husband & wife, father & son, or friends.

Legal documents & taxes are still fairly simple to complete.

Cons:

Partners can sometimes disagree over things. This leads to frustrations & problems with the business.

With a partnership, you will have to slit the profits of a business.

You will usually require a written legal agreement defining things such as profit division, expense/liability division, etc.

Partners die, sell their share of the business, and other things that can hurt the business down the road.

 

Corporation Legal Business Structure

Another legal business structure is the corporation. While there are more sole proprietorships in the U.S., corporations make much more money.

With a corporation, you can do things such as issue stock. Most large business that you know about, are most likely corporations (or some variation of a corporation).

Pros:

You can raise large amounts of capital by issuing stocks and bonds.

You can grow corporations quickly. You can also get some tax breaks if you employ several people.

With a corporation, the business has a complete separation from the owner. In other words, if the corporation goes bankrupt, the corporation has to pay the debtors (not the actual person who started the corporation).

Cons:

Corporations will have larger structures which could mean larger expenses.

Accounting is much more tightly regulated, and corporations must follow complex & time consuming record keeping & regulations.

Some taxes are aimed at larger businesses such as corporations.

 

S Corporation Legal Business Structure

S corporations are similar to normal corporations. There are a few differences in S corporations & normal corporations.

For instance, an S corporation can avoid the "double taxation" that normal corporations face (the double tax is tax on stock to shareholders & corporations).

Also, there can be different variations from state to state with the different types of legal structures & requirements for the different corporation types.

Pros:

S corporations have special treatment on certain issues. For instance, they avoid the double taxation that some corporations face.

Cons:

S corporations are also taxed on additional things when compared to other (smaller) business structures.

They will also have tighter accounting controls & regulations

LLC (Limited Liability Company) Legal Business Structure

LLC's are a relatively new legal structure that a business can use. LLC's try to get the "best of both worlds."  They do this by offering a simple structure, yet they protect the owners from personal liability (like a corporation).

Pros:

They reduce personal liability of the owner(s)

Cons:

They can still require additional taxes.

Not all business can use an LLC structure.

Remember, you can always change your business structure later. Different businesses use different structures.

If you are unsure which structure to use, you should consult a business attorney or accountant.

Getting a Business License