You have the idea, the product, and the cash to back you up – so what’s the next step to getting your business off the ground? Well, you can’t make it official without making your business legal. The trouble here is that there’s a wide variety of potential business structures that you can choose from, and it can be tough to know which one is best for you. After all, the legal structure you choose can impact how your business is taxed, how much liability falls on you, how you can raise funds, and more. To help out with your decision-making process, we’ve laid out 5 of the most common business structures for you to review. This way, you can be well-prepared before you make your next move!

 

Sole Proprietorship

 A sole proprietorship is the simplest business structure to get started. In fact, you may not even be required to register as a business entity! In a sole proprietorship, it’s only you who owns and operates the business – so you also get full control over any business decisions. However, full control in this case means that your personal assets are tied to the business assets, making you personally liable for any debts or obligations that the business has. In spite of this, sole proprietorships offer easy start-up and manageability, so it’s often the structure of choice for small businesses or freelancers who are just getting started.

Pros

  • Simplicity: Sole proprietorships are easy to start and easy to terminate.
  • Cost-effective: There’s often low setup costs and minimal paperwork involved.
  • You’re the boss: You get full control of the business, making it easy to respond to customers and seize opportunities – no hassle required!
  • Tax Benefits: As a self-employed individual, you could receive potential tax deductions.

Cons

  • Unlimited Liability: Sole proprietorships have unlimited liability, putting your personal assets at risk.
  • Limited Capital: It may be harder to secure loans depending on your personal credit and more difficult to gain funding without investors.
  • Tax Burden: Depending on income level, you may face higher personal tax rates as your business grows.

 

Partnership

 Sharing is caring – especially in a partnership. In this business structure, two or more individuals agree to share ownership, profits, losses, and liabilities for the business. However, the owners’ roles, responsibilities, and profit-sharing can be different depending on the type of partnership that they agree to. For example, in a general partnership, all partners share equal ownership, equal profits, equal decision-making power, and equal liability. On the other hand, a limited partnership has a general partner who manages the business’s day-to-day operations and limited partners who act as investors. In this version, general partners might have personal liability for the business while limited partners are only liable for the amount that they invested. Limited partners might also receive a specific portion of the profits as a return on their investment and could have more sway in decision-making if they invested more into the business than their other partners.

Pros

  • Simple to Start: Partnerships are less expensive to set up and require less paperwork than other business structures, such as a corporation.
  • Clearly Defined Roles & Resources: When starting a business, it helps to know who is in charge of what and to have shared resources – like money, skills, and expertise.
  • Multiple Perspectives: Each partner brings a unique set of skills and ideas to the business, leading to better decision-making and more creativity.
  • Loan Opportunities: Two credit histories may be better than one – especially when it comes to securing loans for the business.

 Cons

  • Unlimited Liability: General partners remain personally liable for the business’s debts and obligations, putting their personal assets at risk.
  • Internal Conflict: More hands in the decision-making process means more opportunities for conflict – which could affect business operations and owner relationships.
  • Splitting Up the Money: Depending on how profits are divided among partners, some owners could walk away with more or less income than others.

 

Limited Liability Company (LLC)

This hybrid business structure can offer you the best of both worlds by combining the benefits of both corporations and partnerships. For instance, LLCs can keep your personal assets safe and secure since they protect members from personal liability. Plus, they offer pass-through taxation, meaning that your profits and losses are passed through to members’ personal income – although you’ll still need to pay self-employment taxes. As a result, the benefits of an LLC make it a common choice for medium to high-risk businesses and owners who want to protect their personal assets.

Pros

  • Limited Liability: No more worrying about your assets, LLCs will keep you from being personally liable for business debts.
  • Pass-Through Taxation: Profits and Losses pass straight through to members’ personal income.
  • Flexibility: LLCs can be managed by members or designated members, allowing for different management structures. Plus, you can choose how you want profits divided among members, instead of basing it on their ownership percentages.
  • Fewer Formalities: LLCs typically have fewer regulatory requirements and formalities compared to corporations. No need for annual meetings or extensive record-keeping!

Cons

  • Self-Employment Taxes: Members are still subject to self-employment taxes on business income.
  • Lifespan: In some states, LLCs could have a limited lifespan depending on the tenure of its members and whether the operating agreement includes certain provisions.
  • Formation Costs: Although LLCs are less expensive than corporations, they can still cost you formation and maintenance fees depending on your state.
  • Structural Complexity: The more members there are in an LLC, the more complex the operating agreement can become. Be careful with drafting and management!

 

Corporations

Unlike the business structures we’ve covered so far, corporations are their own thing separate from their owners. This means that corporations can own their own assets and take on all liabilities, doing away with any personal liabilities for those in charge. Additionally, there are various types of corporations, each designed for different purposes. For instance, there are C corporations, S corporations, and nonprofits, among others:

  • C-Corps: The most basic corporate structure that creates a separate, legal business entity from its owners. C-corps are subject to corporate income taxes but also allow for unlimited shareholders and can issue multiple classes of stock, giving you more ways to raise money.
  • S-Corps: Like a C-corp, an S-corp is a legal business entity separate from owners but with a special tax status that allows for pass-through taxation. However, S-corps are limited to 100 shareholders and can only issue one class of stock.
  • Nonprofits: Nonprofits are a special type of corporation designed to serve a specific public or mutual benefit rather than turn a profit. As a result, they can receive tax-exempt status (through 501(c)(3)), although they can’t have shareholders, must be governed by a board of directors, and must keep extensive records to show that any income is being directed toward their mission.

The advantages of a corporation make it a popular choice for large businesses or those seeking multiple investors.

Pros

  • Limited Liability: As separate, legal entities, corporations can keep the personal assets of you and your shareholders safe from any liabilities for business debts.
  • Easier Fundraising: With the exception of non-profits, corporations are allowed multiple shareholders and attract various investors to help you raise large amounts of capital.
  • Long Lifespan: Since corporations are separate, they can continue to live on even if the owners leave the business.
  • Potential Tax Advantages: Depending on the type of corporation that you form, you could be eligible for potential tax deductions and benefits, such as lower tax rates on retained earnings for C-corps or tax exemptions for nonprofits.

Cons

  • High-Cost: Starting and maintaining a corporation can be expensive due to fees, taxes, and compliance costs.
  • Required Maintenance: Corporations face regulatory requirements such as extensive record-keeping and reporting, regular meetings, and compliance obligations.
  • Double Taxation (for C-Corps): Profits from a C-corp may be taxed at the corporate level, and then its dividends may be taxed again at the individual level.
  • Limited Control: Shareholders can have limited control over the business’s day-to-day operations, especially if the corporation’s management is separate from its ownership.

 

Cooperative

A cooperative, or co-op, is a member-owned and operated business designed for the group’s mutual benefit. In a co-op, members are typically involved in every aspect of the business, as workers, producers, and even consumers. This also means that the group of member-owners enjoy an equal share of the profits and equal decision-making power, often done through a vote. The ultimate goal of this business structure is to meet the social, economic, and cultural needs of its members while positively contributing to the community.

Pros

  • Democracy: All members have equal voting rights no matter how many shares they own.
  • Mutual Benefits: Member-owners benefit not only from shared profits, but also from mutual support, collaboration, and enhanced community ties.
  • Funding & Resources: Member-owners can pool resources for the co-op. Co-ops are also eligible for federal grants and other sources of funding.
  • Limited Liability: Members of a co-op are typically not personally liable for any debts or legal settlements, or other obligations.

Cons:

  • Potential Conflict: Co-ops work best when members If there is conflict, it can hinder decision-making and owner relationships.
  • Regulatory Requirements: Co-ops can face specific legal and regulatory requirements that may complicate operations.
  • Complex Formation: Starting a co-op may involve specific paperwork and various state filing fees.
  • Limited Profit Incentive: Co-op members might be less driven by profits, which can impact the business’s growth and competitiveness.

 

Summary

Choosing a legal structure is a big step in the process of starting your business. After all, the structure you pick may shape the future of your business operations! Hopefully after reviewing the structures we’ve laid out today, you have a better idea of which one might be the best fit for your business. Of course, you should always consult your financial advisor and a lawyer before you take the leap and decide on a business structure. No matter what, the future for your business is bright and FFB Bank is here to help from the time you get started to the moment you open the doors!