What Is the Best Form of Business Ownership?
When forming any business more complicated than a sidewalk lemonade stand, you’ll need to decide which of the five main corporate entities you want to register as. Keep in mind, business ownership isn’t synonymous with business structure. You can technically be a business owner—i.e. someone who owns shares of a publicly-traded corporation—without being responsible for the company’s business structure.
Are you curious about what is the best form of business ownership? Today, we’ll cover the five primary types of business ownership:
- Sole proprietorship
- C Corporation
- S Corporation
Business Structures: Key Concepts Explained
Business structures are generally distinguished by their tax requirements, bureaucratic responsibilities, liability protections, and fundraising abilities. The optimal form of business ownership will largely depend on the nature of your company and your future goals. To help you decide, we’ll compare and contrast the business’ structures relationship to the following concepts:
- Formation and costs
- Legal liability
- Decision-making power
- Corporate finances
Formation and Costs
Choosing which business ownership structure you’d like to form is the first step to owning a business. However, there are some general initial steps a business owner must take regardless of which structure they’re pursuing:
- Choose a name – Make sure your name relates directly to your enterprise and is general enough to include the scope of your business as you grow—like using Jane’s Sweets instead of Jane’s Cupcakes. Be sure to double-check DBA (doing business as) registries to confirm that your chosen name is unique. You also have the option to register the business using a legal name and then change the name for a DBA name.
- Tackle formation and registration requirements – This is where the associated costs come into play. Unless you’re structuring your business as a sole proprietorship, there will be fees for creating your business. On top of this, you’ll also need to research what, if any, permits and licenses you’ll need to file in the county or state which you’re registering—which also come with fees.
- Create a business plan and operational budget – It’s best practice to outline your mission, revenue plan, and monthly budget for the first few months to a year. Regardless of your business structure, you’ll need to account for upfront and operational costs, including everything from rent to payroll.
Depending on which of the five legal entity structures you choose, you may end up with limited or unlimited liability. Partnerships (unless they’re limited) and sole proprietorships are saddled with unlimited liability, LLCs and corporations have limited liability.
Let’s look at the distinction between the two types of liability:
- Unlimited liability – If your business has unlimited liability, that means you as the owner (and any partners in the case of a partnership) assume all debts that the business takes on. In the case that your business does not have enough funds to pay its debts, under unlimited liability, your personal assets can be seized in their place.
- Limited liability – If your business has limited liability the “corporate loss will not exceed the amount invested.” In other words, your private assets are safe with limited liability unless there is illegal activity suspected.
All businesses must pay taxes, and the more complex your business structure is, the more complex your tax process will be (covered in-depth below). Which ownership structure you choose will determine which income tax return you complete, and which tax deductions are available to you.
Check out this complete list of documents required by the IRS.
The more people involved with the formation of your business, the less decision-making power you’ll ultimately hold. Structures like a sole proprietorship and limited partnership offer a business owner expansive decision-making power, while large-scale corporations and general partnerships offer owners far less individual control.
Corporate finance is a broad term used to describe how “corporations deal with funding sources, capital structuring, and investment decisions.”
The first part of the definition—funding sources— is what most new businesses will need to focus on in the early stages. There will be financial avenues better suited for certain business structures. For instance, venture capitalists typically will not hand over funds to a sole proprietorship the same way they might for a C corporation. While the vast majority of small businesses are bootstrapped, there are always other financing methods, including obtaining debt via bank loans or giving up equity to venture capitalists.
A sole proprietorship is an unincorporated business owned by one person who shares all personal and business assets and liabilities. You may want to register your business as a sole proprietorship because it’s easy to form and costs little to do so.
- Formation and costs – There is no formal formation process for a sole proprietorship. All you need to do to make your sole proprietorship official is: Check to see what permits or licenses your state requires and file a DBA (doing business as) name, if your legal business name differs from your DBA name.
- Liability – Sole proprietorships have unlimited liability, which, as stated above, means your personal assets are at risk if your business is in debt.
- Taxation – Because there is no legal distinction between business and business owner, you will file your business taxes along with your personal taxes. This makes for a fairly seamless tax day, all you need is your personal income Form 1040, a Schedule C Form, and a Schedule SE Form for self-employment taxes.
- Decision-making power – As sole proprietor you are your own boss, which means all decisions are up to your discretion.
- Corporate finance – As a sole proprietor with no partners to support you financially, you’ll probably need to raise funds to get your business off the ground. It can be difficult to entice investors as a one-person corporation since you can't sell stocks, and traditional banks may hesitate to hand over a sizable loan based on your personal credit alone.
Businesses conducive to the sole proprietorship model include everything from bookkeeping services to professional photography. The beauty of a sole proprietorship is that it’s a solid starting point for any rising entrepreneur.
A partnership is an agreement between two or more parties to operate a business and share its profits. Before we dive into the properties of a partnership, let’s look at the main distinctions between partnership structures.
General vs. Limited vs. Limited Liability Partnerships
All partners share liability and profits equally with a general partnership (GP). Like a sole proprietorship, all members of the GP will face the consequences of unlimited liability. If the ship sinks, you and your partners’ assets are liable to cover the associated costs.
You have more flexibility with a limited liability partnership (LLP). Because the LLP exists separately from the individuals who are a part of it, personal assets are safe from seizure. Like with any limited liability structure though, there is more paperwork involved in the formation and throughout the lifespan of the LLP.
A limited partnership (LP) melds features of a GP and an LLP. One or more partners serve as the general partners who are personally liable for the business’ debts, while the rest of the partners are responsible only for what they’ve invested in the business.
If you’re interested in forming a partnership, consider the following:
- Formation and costs – Partnerships can be formed relatively simply. The main cost is an attorney’s fee to draft a written partnership agreement.
- Legal liability – This depends entirely on which type of partnership you form. An LLP offers limited liability for all partners, while an LP offers this protection for only the silent, or limited, partners.
- Taxation – Like sole proprietorships, partnerships do not pay separate individual and business taxes—each partner is taxed on their share of the income from the partnership. For partnerships you’ll need to file a couple of additional forms in addition to Form 1040 and Schedule SE. Check out the IRS’ full list here.
- Decision-making power – Unlike a sole proprietorship, a partnership requires shared decision-making power. Again, your level of influence depends on which kind of partnership you choose. If you’re part of a GP, you’ll have to come to a mutual agreement with your other partners, no matter the issue.
- Corporate finance – The upside of joining forces with multiple people is that you have multiple bank accounts from which to fund your business.
Common partnerships include those who offer professional services, such as attorneys, doctors, dentists, and architects.
An LLC is a limited liability corporation. Unlike a sole proprietorship or partnership, LLCs offer business owners liability protection. With this comes more paperwork upfront and throughout the duration of the LLC’s existence.
- Formation and costs – LLCs need to file for formation in the state in which they plan to do business and must hire a registered agent who receives documents on behalf of the LLC. You’ll also need to prepare an operating agreement and articles of organization. Also, you may need to publish a notice in your local paper about the formation of your LLC, depending on your state.
- Legal liability – This is the linchpin of an LLC—as a business owner, your personal assets will be protected under limited liability. The only assets at stake are the ones associated with the business itself.
- Taxation – Like sole proprietorships and partnerships, LLCs enjoy what is called “pass through” taxation. This means the LLC members are taxed as individuals, and the LLC itself is not taxed on the profits it makes as a business.
- Decision-making power – LLCs have more flexibility than partnerships when it comes to assigning decision-making roles. Members of an LLC can decide who will run the business, whether that is a hired manager or the owner themselves.
- Corporate finance – LLCs may have more luck with finding outsider funding than sole proprietorships or partnerships, but they won’t be as attractive to venture capitalists as a corporation.
Companies conducive to the LLC structure are typically any enterprise you can conjure up. Household LLCs include Exxon Mobil, Johnson & Johnson, and General Electric.
A C corporation or C corp is a business entity where all shareholders are taxed separately from the company itself. The formation and taxation of a C corp can be daunting, but the potential for growth is essentially unlimited.
- Formation and costs – If you’re structuring your business as a C corp you’ll need to file articles of incorporation with the state in which you’re registering. A C corp may also need to eventually file with the Securities and Exchange Commission (SEC) when it reaches a certain size and number of shareholders.
- Legal liability – The legal liability for the owner or owners of a C corp is limited to the investments which they’ve made with the business—personal assets are safe.
- Taxation – These corporations are required to submit state, payroll, income, unemployment, and disability taxes. The tax process can be lengthy for a C corp, which means you may want to invest in hiring a legal team to handle the process.
- Decision-making power – A C corp is divided into shareholders, directors, and officers. The shareholders are the owners, who in turn are responsible for assigning managerial duties to directors. The board of directors is responsible for enforcing company rules.
- Corporate finance – With the ability to bring on unlimited shareholders, this structure is ideal for raising funds.
Almost all publicly traded companies are C-corps, with well-known examples including Apple, Starbucks, and General Motors.
An S Corporation is similar in structure to a C corp business entity with the added benefit of pass-through taxation. Unlike a C corp, the potential for rapid growth with this business form is limited.
- Formation and costs – Because an S corp enjoys special tax status from the IRS, you must adhere to the following: be located in the U.S.; have only estates, individuals, and certain trusts as shareholders; have fewer than 100 shareholders; and own one kind of stock. Owners must submit articles of incorporation to the proper governmental entity.
- Legal liability – Like every structure other than a sole proprietorship and partnership, the S corp structure separates you as an individual from the company, meaning your private assets will not be seized in the case of the company failing to pay its debts.
- Taxation – Like a sole proprietorship, partnership, and LLC, an S corporation enjoys the benefit of pass-through taxation. The owners are taxed on an individual level instead of a corporate level.
- Decision-making power – Like a C corp, an S corp business form is run by a board of directors who report to the company’s shareholders.
- Corporate finance – Like a C corp, this business structure is appealing to investors because of its size, though you will not be able to benefit from unlimited shareholders as you must cap your number at 100.
Examples of an S corp may be any small- to medium-sized company that wants to involve shareholders in the business to help with capital, but doesn’t want to face double taxation.
Business Ownership Made Easy
Deciding which structure is best for you as a business owner depends on a number of factors. The simplest method for deciding is to understand your vision for the company and then select the entity that matches your goals.
Regardless of which structure you choose, you’ll want to keep your finances in order. With Ramp’s corporate card and built-in spend management platform, you can track your company spending as you scale. Check out Ramp’s capabilities today.
Entrepreneur. The Legal Ins and Outs of Forming a Partnership.