Types of Businesses and How to choose one
October 16, 2022
If you are considering starting a business, it is important to think carefully about the type of business structure you will choose to start it up, as this is what will affect how much you pay in taxes in the future, the documentation you must file, your personal liability, and even your ability to raise money.
However, choosing the right type of business requires careful research and evaluation, so in this article we will discuss the different types of businesses and offer advice on how you can choose which type to start.
Types of Businesses
We will now show you the most common types of commercial structures, although it is important to keep in mind that liability, ownership rules, taxes and filing requirements may vary by state.
1. Sole proprietorship
This is the simplest type of business, requiring only one person (or even a married couple) to be incorporated and to be responsible for all the profits and debts of the business. If you are thinking of working alone from the start, this may be the best option.
In addition, it is often especially attractive because income and expenses are included in your personal income tax records. Your gains and losses are recorded on the Schedule C tax form, and the amount is transferred to your personal income tax return.
On the other hand, losses you suffer in business can offset income earned from other sources. With this type of business, you have full ownership and make all the decisions. It has a disadvantage, though, because a sole proprietorship refers to you being in charge of everything, so your personal assets could be at risk to satisfy a business debt or settle a legal claim filed against you.
A partnership is the ideal choice if your business is going to be owned and operated by several people. This type of business comes in two forms: general partnerships and limited partnerships. First, we have the general partnership, where the partners assume liability for the debts.
On the other hand, we have the limited partnership, where there are general and limited partners. Limited partners are only investors and have no control over the company and are not subject to liabilities. The general partners own and operate the business and assume the liabilities.
So, unless you intend to have multiple passive investors, a limited partnership may not be the best type of business to start as a new business owner because of the administrative complexities and filings required.
Conversely, if you expect to have two or more partners actively involved in the business, a general partnership is easier. One of the advantages of this type of business is the tax benefits. A partnership does not pay taxes on its income but instead passes profits and losses through to the partners. Although they are generally more expensive to start because more extensive legal and accounting services are required.
3. Limited liability company (LLC)
This business structure allows owners, partners, and shareholders to limit their personal liability to protect their personal assets. Also, keep in mind that an LLC is not incorporated but enjoys the limited liability of a corporation and can be taxed as a sole proprietorship, partnership, or corporation.
Some of its benefits include limitations on the number of shareholders the company can have. In addition, any owner or member can have a full participatory role in the operation of the business, but there is also flexibility with the distribution of profits.
Regarding profits and losses, they do not have to be distributed in proportion to the money invested by the investor. The disadvantage of this type of business is that, because LLCs are a relatively new business structure, the tax treatment may vary from state to state.
4. Corporation – C corp
While corporations offer the greatest amount of personal liability protection, the cost of forming a corporation is higher, as it requires more extensive reporting, record-keeping, and operational processes.
Also, corporations, which are completely independent of shareholders, pay income tax on profits and, in some cases, may be taxed twice. But they have an advantage when raising capital because they can raise money by selling stock. Stock options can be useful in attracting employees.
5. Corporation – S corp
An S corporation has the liability protection of a corporation along with various tax benefits. You see, its owners can use the cash method of accounting if they have no inventory, and let’s not forget that they can have up to 75 shareholders, which allows them to attract more capital.
Likewise, S corporations must file articles of incorporation like all corporations and hold meetings of directors and shareholders. They must allow shareholders to vote on major decisions. Finally, remember that they can only issue common stock, which could affect the corporation’s ability to raise capital.
6. Corporation – B corp
Also called a benefit corporation, it is a for-profit corporation driven by mission and profit. They are taxed in the same manner as C corporations, but focus more on purpose, accountability and transparency.
7. Corporation – Nonprofit
Ultimately we have nonprofit corporations that are organized with the intention of doing philanthropic work. In addition, because they have a social purpose (their work benefits the public), they can receive tax-exempt status and pay no income taxes. They follow organizational rules that are like a C corporation but also have special rules regarding profits.
How to choose which type to start
At this point, it is time to talk about the main factors you should take into account before choosing the type of legal structure for your company.
- Flexibility: As a fundamental objective, you should select a type of business that allows you maximum flexibility with the ownership structure. In addition, you should consider the goals, concerns, needs and financial situations of each owner.
- Liability: Another important factor in wanting to incorporate a business is the extent to which you need to be protected against liability. You should examine the potential liability of your organization and decide whether you can personally assume the risk. If this factor is very limited in your case, a partnership or sole proprietorship is probably not the best type of business to start.
- Complexity: Now you will need to establish the level of complexity you wish to take on with your business. Usually, sole proprietorships are the simplest option, and incorporating your business can become very complex, with state and federal reporting requirements.
- Taxes: On the tax side, it is necessary to consider the tax implications for the organization and what the opportunities are to minimize taxes. Remember that there are more tax options for corporations than for partnerships or sole proprietorships. Also, double taxation can be a problem with corporations but can be avoided with an S corporation.
- Control: You will also need to determine the amount of control you want over the business. If you need to have total control, an LLC or sole proprietorship may be the best option, but even though a single person may control a corporation, as the business grows, it will become a board-directed entity.
- Capital investment: The last aspect you should review is capital. If your goal is to seek outside financing for your business, you may want to establish a corporation, as corporations can raise additional funds and sell stock instead of sole proprietorships, which can only raise funds through their personal bank accounts or by hiring partners.
To conclude, it only needs to be said that there is no easy or specific answer or formula for every new business to follow after selecting a structure. In fact, many online retailers start as sole proprietorships or partnerships and wait to incorporate, but the exposure to unlimited personal liability can be frightening.
Nevertheless, if you really want your business to be successful in the future, you will have to take the risk at some point. Therefore, we believe these tips may give you some guidance on how to get started. Finally, be sure to contact a lawyer once you have decided on the business structure you are going to opt for. This way the legal processes will not be so difficult to follow.