Types of Business Structures
From LLC to C corp to co-op, learn the pros and cons of common business structures and what might work best for your business.
Whether you have a small freelance operation as a party of one, or manage a mid-size company with a pool of employees, it’s important to set up your business for success. You might be thinking of things like setting realistic financial goals or assembling a solid 5-year business plan, and while both of those are super important, they’re not the only steps to success.
Part of your successful business journey includes understanding the different types of business structures — the benefits, the disadvantages, and everything in between — because the way you set up your company matters.
We’ll cover the common types of business structures, from simplest to most complex, so you have a good idea of which one will work best for you as you’re starting your business.
With a sole proprietorship, you are the sole owner of your business — meaning you make all the decisions and control every aspect of daily and financial operations. If you want to be the master of your domain, this is the business structure for you.
A sole proprietorship is the simplest and typically least expensive business structure to set up. It’s ideal for independent contractors, people just starting in their field, or entrepreneurs who want to test a business idea before incorporating it. Examples of sole proprietors include freelance writers and photographers, artists, franchisees, landscapers, and more.
Pros of Sole Proprietorship
- Simple set up: Just file for appropriate state or local business licenses and permits, and you’re ready to go. You can always file for a Doing Business As (DBA) name, but that step isn’t necessary. Your own name is considered the legal name of your business, but a DBA is a nice option if you want to market yourself under a more creative title. Learn more about creating a business name.
- Complete control: No need to answer to anyone but yourself with a sole proprietorship.
Cons of Sole Proprietorship
- Liability risk: Because your name is your business, there is no distinction between the two. This means that any business risks, debts, taxes, and so on become your personal risks.
- Funding & Financing: As a sole proprietor you may have a harder time securing financing than other business structure types. An incorporated business is eligible for government funding and can raise funds fairly easily due, in part, to the legal distinction that comes along with corporate types.
Read more about sole proprietorship pros and cons.
A partnership is a type of business ownership with more than one partner in the business. It’s popular in fields with licensed professionals, like accounting, law, or medicine. There are two common types of partnerships: limited liability partnership and limited partnership.
A limited liability partnership (LLP) does just what it says: It limits the personal liability of each partner from their fellow partners’ mistakes. However, many states only allow certain types of businesses to form LLPs. For example, the state of California only allows professionals like lawyers, architects, or accountants to form LLPs.
If you have an investor partner, but you still want to be the main owner (also known as the general partner, it may make more sense to form a limited partnership (LP) . In an LP, the investor is a limited partner, meaning they are only liable for the amount they invested and are not responsible for managing day-to-day operations. You, as the general partner, are liable for all debts.
Pros of Partnerships
- Easy set up: Like a sole proprietorship, it is generally easy to set up, with the added step of creating a partnership agreement.
- Good for business partners: Do you have a friend who is skilled in the same field and wants to partner up? With a partnership, you both can try out a business idea before formally filing as an LLC or corporation.
- Funding & Financing: As part of a partnership, you have greater capacity to borrow money from a bank or other lender.
Cons of Partnerships
- Taxed personally: Because a partnership isn’t considered a formal company, each partner is taxed personally (also known as a pass-through tax) based on what is laid out in the partnership agreement.
- Some partners are liable: Depending on what type of partnership you have, you may or may not be personally liable for the business’s debts and risks.
- No partnership agreement means unclear guidelines: A partnership agreement isn’t required, but it is highly recommended for clearly outlining the terms of ownership, financial contributions of each owner, dissolution, and more. If you’re a little confused about whether you should whip up an agreement, hire a lawyer who can give you sound advice.
A limited liability company (LLC) is all about keeping things separate — well, your business and personal assets, that is. Think of an LLC as a combination of a sole proprietorship, a partnership, and a corporation. Like a sole proprietorship and partnership, profits and losses are part of pass-through taxation, which goes straight to your personal income.
Pros of an LLC
- Protects personal assets: Unlike a sole proprietorship and some partnerships, forming your business as an LLC protects your personal assets (like your home and car) from being used to pay off business debts.
- Flexibility: Do you want to file your solo business as an LLC, or do you have other owners (known in the LLC world as “members”) that want to be involved? Either option is acceptable with an LLC.
- Profit sharing: If your LLC is multi-member, everyone can have an equal piece of the profit pie.
Cons of an LLC
- More expensive: An LLC is typically pricier than filing as a sole proprietor or partnership because you’ll need to create an operating agreement, get a registered agent, and pay LLC registration fees for your state. Learn more about switching from a sole proprietorship to an LLC.
- Limited Liability: An LLC structure doesn’t protect your personal assets in every circumstance. A judge can take an action called “piercing the corporate veil,” which puts your personal assets at risk. For example, if you don’t clearly separate business transactions from personal transactions a judge may pierce the corporate veil.
Now that we’ve covered the simpler company structures, let’s get down to business (sorry, we had to) with understanding corporations.
C Corporation, commonly referred to as a C corp, is a blanket term for any type of corporation. S corps, nonprofits, and cooperatives all fall under the umbrella of a C corp. This type of business structure is the most complex because it involves more rules and regulations — from taxes to shareholder profits, just to name a few.
Pros of a C Corp
- Easy to finance: A C corp has a better chance of attracting investors because it can have an unlimited number of shareholders and stock options. The more shareholders you have, the more funding that comes in, so you can grow your business more easily. This is why many startups choose this business structure. Also, it’s typically easier to get bank financing, like a small business loan, with a C corp.
- More tax advantages: C corps enjoy more tax advantages than an LLC, sole proprietorship, or partnership, like writing off salaries, bonuses, and charitable contributions.
- Liability protection: Like an LLC, a C corp is a separate business entity, so owners are not liable for the company’s debts.
Cons of a C Corp
- Expensive set up: There are several documents that a C corp business must file — articles of incorporation, corporate bylaws, a shareholders agreement, and a stock purchase agreement. It’s probably a good idea to hire an attorney to help you draft these documents and navigate the filing process. Plus, as with other types of business structures, you’ll need to apply for necessary state and local licenses and permits.
- Double taxation: This is considered one of the biggest downsides to a C corp. The business will be taxed at the corporate level for both federal, which is 21%, and state, which varies. Then, the owners or shareholders are taxed on their dividends and capital gains from selling shares.
Many small business owners consider an S corporation, commonly referred to as an S corp, to be the ideal structure for their company because it offers some of the benefits of a C corp, but has fewer tax regulations.
Pros of an S Corp
- Limited liability: Like C corps and LLCs, S corps are considered legally separate from their owners and shareholders, meaning less personal risk for everyone at the company.
- Pass-through taxation: This is one of the biggest reasons businesses choose to form an S corp over a C corp — no double taxation. S corps taxes are treated the same as a sole proprietorship and an LLC, where the tax on profits and losses of the business are passed through to the owners. Basically, this means you’re only taxed once.
Cons of an S Corp
- Limited shareholders: S corps have a shareholder limit of 100, and they must be U.S. citizens, so this could be limiting for young companies with high growth potential.
- Pass-through taxation: We’re including pass-through taxation again in this cons list because it affects investor attraction. Investors typically choose to fund a C corp over an S corp because they don’t want to pay taxes on the company’s profits. They only have to do this with a C corp if they receive a dividend.
You’ve heard of nonprofits before, what exactly are they? A nonprofit is a type of corporation specifically formed to help the public, like a religious or educational organization or a charity. Many nonprofits are designated as 501(c)(3), which is the IRS tax exemption they qualify for.
Pros of a Nonprofit
- Limited liability: Nonprofits enjoy the same limited liability as other corporations and LLCs.
- Tax-exempt: All nonprofits are tax-exempt, meaning their income is not taxed at the federal or state level.
- Easier to fund: Anyone can donate to a nonprofit, and the nonprofit itself can apply for state and federal grants.
Cons of a Nonprofit
- Lots of paperwork: For a corporation to operate as a nonprofit, it must file a lot of paperwork, including articles of incorporation, bylaws, a statement of information (SI-100), and federal and state tax exemption applications. You can learn more about federal filing requirements here.
- Limited Purpose: A nonprofit organization, In order to be exempt under the tax laws, can only perform certain functions listed in their bylaws. If an organization goes outside those limits, it may have to pay taxes on some of its income, pay penalties, or lose its exemption entirely.
Commonly referred to as a co-op, a cooperative is a legal business entity formed for the benefit of its members. Co-ops are popular in the agricultural industry, but they also exist in other spaces. You might be surprised by the number of famous companies that are structured as cooperatives.
Pros of a Cooperative
- Democratic governing: All co-op members have an equal vote on the governance of the business. This type of business ownership promotes equity, meaning that no matter how much a member invests in the co-op, they will still only have one vote.
- Tax advantages: Co-ops are taxed like an S corp, where the company’s taxes are passed to each member. Another perk? Co-ops don’t pay federal income tax.
- Grant opportunities: There are various grant programs — like those offered by Cooperative Development Foundation — to help cooperatives receive funding.
Cons of a Cooperative
- Requires constant member participation: The famous quote, “The whole is greater than the sum of its parts,” applies to the operation of a co-op. If some members don’t actively participate, the business may not perform well.
How to Choose the Right Business Structure
Now that you’re armed with this knowledge about business structures, where do you go from here? It may be helpful first to set up your small business goals, considering what you want ownership to look like, how formal you want the structure, and your company’s purpose.
For example, if you’re venturing out as a freelance graphic designer, you may want to start with the more informal sole proprietorship. If you are the owner of a tech startup, you may want to consider setting up the business as a C corporation.
But keep in mind that every situation is different, and what works for one business owner may not work for another. When in doubt, seek the advice of a business mentor, lawyer, accountant, and financial planner for small business to make sure you’re headed down the right path.
When everything is said and done, and you’ve set up your company with the type of business structure that works best, it’s time to get to work. Reach out to current and potential clients, create your marketing plan, and consider using EZ Texting to help grow your business.
How EZ Texting Can Grow Your Business
Now that you understand the pros and cons of each business structure, it’s time to take the next step in setting up your small business goals. Defining your optimal business structure is just one of them.
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