The Different Types of Business Structures
When starting your own company, few decisions are as important as determining how you’ll structure your business. As a new business owner, you may be confused about the different types of business structures. The business entity you settle on can impact your business’ future in a variety of ways, including taxes, liability, and costs.
To help you settle on the right structure for your company, weigh the pros and cons of the following options:
What is a Sole Proprietorship?
A sole proprietorship legal entity is a company that’s owned and operated by a single person.
The legal distinction between the business and the owner is blurred, since it’s not considered a separate entity. This means that there’s no distinction between the business owner’s personal and professional assets and liabilities.
Businesses that are best suited for sole proprietorship status include small, often local-based businesses, such as housekeeping companies, contractors, and catering outfits. However, keep in mind that a sole proprietorship legal structure is different from an LLC business entity.
The Pros of a Sole Proprietorship
If you’re looking for the most straightforward route to starting your business, consider pursuing the sole proprietorship structure. Benefits include:
- Easy to form – All you need to form a sole proprietorship is your business acumen and a registered business name. Sole proprietors don’t have to create a payroll account or file complex financial statements.
- Ideal for a low-risk business startup – With a sole proprietorship, business owners can get up and running even if they have limited capital. Because sole proprietors have only themselves to hold accountable, the time frame between ideation and execution is short.
The Cons of a Sole Proprietorship
Becoming a CEO, administrator, manager, and an employee all at once can be mentally taxing, and risky. With sole proprietorship there is:
- Unlimited liability – When you’re the sole proprietor, there’s no limit to the liability you as the owner may face including the loss of personal wealth and assets. Your personal and business finances are one and the same. This is why “low-risk” businesses are often suited for sole proprietorships—any business activity with more risk may expose the owner to significant personal assets risk.
For taxes, sole proprietors need to report their income and losses alongside their personal income taxes. However, the two categories need to be kept separate. Once that’s done, you need to submit a 1040 Form and then pay an estimated self-employment tax every quarter.
What is a Partnership?
A partnership is a business agreement between at least two people. Together, they agree to manage and operate the company in exchange for a share of the profits and ownership.
Depending on how you’d like liability and profits shared between partners, you will choose one of four kinds of partnerships:
- General partnership (GP) – Profits and liability are equally shared.
- Limited partnership (LP) – An LP comprises two or more partners, with a general partner running the business and the limited partners playing a smaller role with less liability.
- Limited liability partnership (LLP) – In an LLP, all partners share the same management duties and the same liability. The liability is limited (hence the name) because it doesn’t fall on one person.
- Limited liability limited partnership (LLLP) – This includes general partners, who share liability, as well as limited partners, who share limited liability.
Businesses that are best suited for partnerships as a legal entity are typically those focused on professional services or a specific expertise. For example, doctors, lawyers, engineers, and other professionals often form partnerships.
The Pros of a Partnership Agreement
Many entrepreneurs and professionals choose to structure their business as a partnership agreements for inherent benefits like:
- Liability protection – Depending on whether you choose to form a general partnership, a limited partnership, or a limited liability partnership, you have the flexibility to create more protections for your personal assets.
- Teamwork – A partnership provides business owners with a sounding board for ideas as they typically join forces with like-minded individuals who each specialize in a different area. A strong team also allows for easy division of labor.
- Access to capital – Getting a new business off the ground is expensive. Unlike a sole proprietorship, a partnership creates at least two sources of capital. Sharing financial responsibilities with your partners creates a safety net for yourself and for your business.
The Cons of a Partnership
While establishing a business partnership and working as a team can be a boon for your enterprise, there are some potential fallbacks, like:
- Possibility of conflict – It’s human nature to have a difference of opinion. Depending on the severity of these differences, your partnership could suffer permanent damage.
For taxes, partnerships that have two or more employees are expected to pay personal income taxes, self-employment taxes, and submit their estimated income tax alongside a 1065 form.
What is a C Corporation?
A C corporation (C corp) is any business where the owner(s) are completely separate entities. This grants the greatest amount of protection from personal liability with practically unlimited potential for growth.
When you’re looking at the different types of business structures, you’ll find that most publicly traded companies are C corporations, and a C corp is the most common type of corporation (compared to an S corp or LLC).
The Pros of a C Corp
There’s a reason why C corps are so common among large corporations. Benefits to structuring your business as a C corp include:
- Increased funding options – C corps have shareholders and can have an unlimited number of investors, which allows for greater potential growth. It also becomes easier to raise the capital needed to continue scaling the business.
- Limited liability for owners – Unlike sole proprietorships and partnerships, the owners of the company are not personally liable. The only asset they will lose if legal or financial trouble comes is what they've already invested in the corporation.
The Cons of a C Corp
A C corp can grow quickly and generate a huge amount of revenue (think Apple or Starbucks). But there are a couple of downsides, including:
- More paperwork – A C corp is legally expected to keep more detailed records and release more financial reports at both the state and federal level. You’ll likely need to hire a team of accountants and lawyers, which can be financially straining for small businesses with limited resources.
- Double taxation – If your C corp makes a profit, the business will be taxed. Investors will then be taxed on proceeds from their dividends. This results in a double tax.
For taxes, a C corp must file corporate tax returns via Form 1120.
What is an LLC?
A limited liability company (LLC) is a private limited company that makes a legal distinction between the owner and the business. If the business gets sued or files for bankruptcy, the owner’s personal assets remain safe.
An LLC combines features of both a corporation and a sole proprietorship or partnership. LLCs can range from giants to small startups found on any main street in America.
Pros of an LLC
When determining which business structure you’d like to pursue, consider these LLC advantages:
- Liability protection – Like a C corp, members of an LLC are not held personally liable for the actions of the company.
- Easy to start – Similar to a sole proprietorship or partnership, the paperwork required for an LLC is much simpler than that required to start a C-corp.
- Not taxed on the corporate level – An LLC’s profits go directly to its members, meaning they aren’t taxed by the government on the company level and are only taxed once.
Cons of an LLC
An LLC may seem like the best of both worlds, combining the benefits of a C corp and sole proprietorship or partnership. But there are drawbacks, including:
- Increased startup costs – Launching an LLC costs more than getting started as a sole proprietor. All states have LLC startup fees, though the price varies. You can find a map of LLC fees here.
- Self-employment taxes – Unless you file forms to be taxed as an S corp, your LLC will, by default, be taxed as a partnership. This means members will have to pay a self-employment tax.
What is an S Corp?
An S corp is structured similarly to a standard corporation except for the fact that it helps the owners avoid double taxation. The S corp avoids paying business taxes by reporting losses and revenue. The shareholders then have to note everything when they personally file their taxes.
The Pros of an S Corp
S corp stands for “Subchapter S corporation,” getting its name from its special tax status granted by the IRS. The greatest asset of structuring your corporation as an S corp is:
- No double taxation – The linchpin of an S corp is that it functions at a high level as a corporation without the drawback of double taxation.
The Cons of an S Corp
While a C corp has the potential for an unlimited number of shareholders, an S corp does not. A downside to structuring your corporation as an S corp is:
- Limits on registration – Only certain enterprises qualify for S corp status. If your company has 100+ stakeholders or a stakeholder that isn’t a U.S. citizen, you can’t be registered as a S corp. S corps can also only have one class of stock.
S corps don’t pay income tax, but revenue and business losses will be deducted from shareholders’ tax submissions included on their 1120-S form.
Ramp: A Business Startup’s Best Friend
Once you’ve studied the different types of business ownerships and chosen your preferred structure, you’ll be ready to file, obtain an EIN, and get to work. It also means you’ll be prepared to apply for a business card.
Ramp is the only corporate card that strengthens your finances. It not only increases your liquidity and has higher limits than a personal card, but also comes with integrated expense management software that helps you monitor and control your spend, streamline your month’s end close, and prepare for tax season.