Starting a business is a big step for any entrepreneur. The journey into entrepreneurship can be challenging and filled with many important decisions.
One of the most crucial choices you'll face is selecting the right business structure.
This decision greatly influences how your business operates, how much tax you pay, and how profits are distributed.
You should be very careful while selecting a business structure.
While you can run a business on your own, forming a partnership has proved to be beneficial too.
So, What should you do next? We have simplified the decision-making process for you.
We have a detail on the business structures and factors that you should consider before choosing them.
Go through them to make a decision that benefits you in the long term.
Types of business structures
1. Sole proprietorship
A sole proprietorship is a form of business where you can have complete control over your business.
There are no partners and a single person is responsible for the profit and losses.
The business assets and liabilities cannot be differentiated from the personal assets and liabilities. The business owners can get a trade name but cannot sell stocks.
Such business structures are generally chosen by craftsmen and storekeepers who want to keep complete control over decision-making with them.
Advantages:
- You can have complete control over the business and you can make independent decisions.
- Business profits can become part of personal income tax return
- It has a simple legal structure with minimal paperwork and cost
2. Partnership
Two or more people come together to run a business and form a Partnership. All the partners contribute to the business in terms of capital, skill, and experience.
A partnership agreement is created to formally enter into a partnership. The partners own the shares of the company.
The no. of shares decides the liability, responsibility, and profit share of the partner. There are two types of partnerships:
2.1. General partnership
Two or more owners share the rights and responsibilities in this type of partnership.
It is a great idea for anyone who does not want sole ownership of the business.
Every partner is the co-owner of the business.
2.2. Limited partnership
In a limited partnership, we have general partners and limited partners. The general partner manages the business and has unlimited personal liability.
Then we have a limited partner whose liability in the business is limited to their investment.
They can also be called silent partners as they are not actively involved in running the business.
Advantages:
- Less legal obligations as the taxes are paid by each legal partner who pays their self-assessment tax. There is no need for a corporation tax return.
- It is simple to register a partnership for taxation. Partners can go online and individually register themselves for self-assessment.
- You can benefit from the support and companionship of your partner while starting a business.
3. Limited Liability Company (LLC)
Limited Liability Company (LLC) is the business structure that brings in flexibility and tax benefits.
It offers liability protection to the business owners where their assets cannot become a business liability.
The income earned can be taxed under personal income. There is no limit on the number of team members.
There is no equal division of profit and loss. The cost of forming an LLC can be different for every state.
Advantages:
- Business owners get a protective shield against liabilities
- It is not considered a separate entity for taxation. The members pay the taxes through personal income tax.
- It is a hassle-free business structure where you do not need a board of directors, strict record keeping, and extensive paperwork.
4. Corporation
The corporation is considered separate from the owners and it has the rights to sue and sell properties along with the ownership rights as stocks.
There are different types of corporations:
4.1. C corporations
The shareholders of such corporations become their owners and they get the interest on their investments.
It is a separate legal entity that can make profits or can be taxed. The corporation is separate from the shareholders.
A shareholder can disassociate from the corporation without affecting the regular functioning of the corporation.
It protects the owners from personal liability. Forming a corporation is an extensive and expensive process.
4.2. S Corporation
S corporation is exempted from the double taxation that occurs in the case of a C corporation.
The owners are protected from personal liability. Some parts of the profit and loss are passed through to reflect the owner’s personal income.
This part is not considered for corporate tax calculations.
4.3. Closed corporation
These are privately held companies where generally the shares cannot be used for public trading.
A small group of shareholders can run such corporations. The owners can allocate the stocks to the family members.
4.4. Nonprofit corporations
Such corporations are formed to benefit the public in different ways. They receive tax exemptions on their profits.
However, the owners need to follow special rules to use the profits and cannot invest it the way they want.
Advantages:
- Owners get asset liability protection. The corporation is a separate entity and shareholders are not responsible for debts.
- Ownership is easy to buy and sell as it depends on the percentage of stock ownership.
- Easy to raise funds by selling stocks
5. Cooperative
This business structure allows the members to use their profits and earnings. The shareholders become members of the cooperative.
The member has the voting power to run business directives. The board of directors and officers run the cooperative.
Advantages:
- All the members get equal voting rights
- There is no restriction to limit the number of members
- They have a democratic management
Factors to consider before choosing the business structure
1. Understanding of business types
The first step is to understand different types of business structures. You have to find out the business structures available in your city.
Explore their benefits and disadvantages. Choose the business structure according to your business goals and needs.
If you have started a business and it's not giving the expected outcome, then you can explore switching the business structure.
Let’s say you can change your business from LLC to S Corp. But before taking any step, you need to understand every business structure.
2. Control
You need to decide the kind of control you want to have over your business. You can go for a sole proprietorship or an LLC if you want to primarily control your business.
If the business is very basic, like a bakery, then sole proprietorship is a great option. But in case you want to raise funds, you must opt for a public limited company.
Once you decide the kind of ownership you want in the company, selection of the business structure will become easy.
3. Capital investment
Even if you are a small business, you need capital for investment to effectively manage the small business expenses.
A small business can use money from their relatives and friends. But if you are planning something big, you might need to go public.
You may need investment with shares. Keep this in mind before choosing the business structure.
4. Consider company goals
What do you aim to achieve with the business? It may be to educate people about something and do social service.
You may not get into the hassle of opening a business and worrying about taxes.
You can think about running as a non-profit corporation where you can get tax exemptions.
Keep clarity on the long-term goals to reap the full benefits of any business structure.
5. Evaluate your risk tolerance
Different types of business structures can subject you to different levels of risk.
You can share the liability with your partner in a general partnership but the same would not be true in a Limited partnership.
You can have unlimited liabilities with the latter. Assess the risks and liabilities you can tolerate at a personal level and then get into any business.
6. The complexity of the business
Small businesses can choose to go with business structures that require minimal operational complexity.
If you have a bakery then straightforward go for sole proprietorship as it has a simple legal structure.
Legal and operational complexities would invest your energy and resources into their maintenance.
7. Calculate the taxation
Taxation has a huge impact on your income. Some business structures let you differentiate between company profits and your income.
In some others, the company profits may be counted under your income. Calculate what kind of taxation that benefits you.
When choosing your business structure, it’s also wise to think about how you’ll handle your annual tax calculations—especially if you plan on operating as a freelancer or sole proprietor.
Estimating your tax liability can be challenging, but using a dedicated freelance income tax calculator can make the process much easier by factoring in self-employment tax rates, deductions, and credits based on your filing status.
8. Hire an expert
Choosing a business structure and calculating taxation is not easy and requires expert opinions.
You can go ahead and hire an expert to help you understand different aspects of any business structure.
Check out the reviews of the agents you hire to simplify your work.
You can search for something similar to ‘Northwest Registered Agent Reviews’ to find the best agent business that can help you register your business under the best-suited business structure.
Conclusion
Business structure plays a crucial role in the success of any business.
Many factors influence the decision of choosing a business structure including control, investment, taxation, complexities, and risk tolerance.
Evaluate every factor thoughtfully to arrive at a profitable decision. It would be a great idea to hire financial experts to get advice on the selection process.
Selecting the right business structure can help you set a strong foundation for your business.