When starting a new business venture, one of the most foundational early decisions is choosing your business structure. The legal structure you register under dramatically impacts everything from day-to-day operations, to taxes, to personal liability.
This article provides an overview of the main types of business structures, with analysis of the relative advantages and disadvantages of each. Evaluating these key differences allows you to determine the best fit based on your specific situation and goals.
Definition of Business Structures
A business structure refers to the legal classification a company registers as at inception This classification determines how a business is taxed and the level of personal liability protection afforded to the owners. The main types of business structures are:
A sole proprietorship is a business owned and operated by one individual. The business is not considered separate from the owner.
A partnership involves two or more co-owners collaborating to operate a for-profit business together. Partners evenly split profits, management duties, and liability.
Limited Liability Company (LLC)
An LLC structure combines aspects of partnerships and corporations. It shields personal assets of owners while allowing pass-through taxation.
A corporation is a legal entity owned by shareholders. It is considered separate from its owners and thus they have limited liability.
A cooperative business is jointly owned and democratically controlled by customers or workers for their mutual benefit. Profits are shared amongst members.
Now that we’ve defined the primary business structures, let’s compare their relative pros and cons.
Pros and Cons of Each Business Structure
- Simplest structure with few legal formalities
- No separate tax filing – profits pass through to your personal returns
- Easy to dissolve the business if needed
- Owner has unlimited personal liability for debts and legal claims
- Hard to raise investment capital for growth
- Continuity challenges if the owner steps away
- Easy to establish with partnership agreement
- Shared capital, expenses, workload and expertise
- Pass-through taxation
- Joint and several liability – partners liable for each other’s actions
- Shared profits dilute incentives
- Potential for conflicts and decision gridlock
Limited Liability Company (LLC)
- Limited liability protection for owners
- Pass-through taxation flexibility
- Less regulation than a corporation
- More complex to establish than a sole proprietorship
- Self-employment taxes apply to owners’ income
- Difficult to raise capital from investors
- Limited liability for shareholders
- Additional credibility with customers
- Continuity even with ownership changes
- Easier to raise capital through stock sales
- Most complex and expensive to set up and maintain
- Double taxation on profits and dividend distributions
- Extensive recordkeeping and reporting requirements
- Democratic control by members
- Focus on member needs over profits
- Tax exemptions in some cases
- Challenge balancing member interests
- Generally smaller scale operations
- Limits on fundraising options
- Less incentive for individual performance
Factors to Consider When Choosing a Business Structure
Choosing between entity types depends on weighing factors like:
- Ownership structure – Single vs. multiple owners
- Liability protection needs
- Raising investment capital
- Profit/tax considerations
- Governance complexity
- Costs and administrative requirements
- Flexibility for structural changes later
An attorney can provide guidance on selecting the best structure aligned with your business goals and situation.
The business structure you choose has significant long-term implications. Evaluate the pros and cons of sole proprietorships, partnerships, LLCs, corporations, and cooperatives relative to your needs. Weigh factors like liability protection, taxation, costs, governance, and capital requirements. Consult legal counsel to ensure you select the most strategic structure to set your new venture up for success.