How to Choose the Best Business Structure

Forming business structures

Business (MP) You’ve had a wonderful idea to create a business and have done your diligence, and maybe have a plan. Now would be the time to choose the right business structure to complement your great idea. The most common forms of entities in use in the United States are the sole proprietorship, general partnership, limited liability company (LLC), and corporation. Each form has advantages and disadvantages in setup, cost, taxation, liability protection, reporting requirements, and such.

The business formation you choose can have legal and tax ramifications. Below I’ve gathered the most used company structures and added some tidbits to help you with your choice. Selecting the right business structure requires a delicate balance of competing considerations. So, select, plan and organize your company for success. Below you will find good information about each business type structure.

Common Forms of Business Structure

1. Sole Proprietorship

A sole proprietorship is one individual or married couple in business. Sole proprietorships are the most common type of business formation. This type of company is pretty simple to form and run and may enjoy greater flexibility of management, fewer legal controls, and fewer taxes. However, you would be personally liable for all debts incurred by the company.

The Sole Proprietorship Advantage

  • Sole proprietorship carry little, if any, ongoing formalities.
  • Owners may freely mix business and individual assets.

The Sole Proprietorship Disadvantage

  • Owners cannot raise capital by selling an interest in the business.
  • Sole proprietorships rarely survive the death or incapacity of their owners and so don’t keep their value.

2. The Partnership(s)

A General Partnership consists of 2 or more persons (usually not a married couple) who agree to contribute money, labor, or skill to a business. Within this company type organization, each partner shares the profits, losses, leadership, and each partner is personally and equally liable for debts of the partnership. Formal rules of the partnership are usually contained in a written partnership agreement.

A Limited Partnership consists of one or more general partners and one or more limited partners. The general partners manage the company and share fully in its profits and losses. Limited partners share in the profits of the company, but their losses are limited up to their investment. Limited partners aren’t usually involved in the day-to-day operations.

The Partnership Advantage

  • Partnerships do not require annual meetings and require few ongoing formalities.
  • Partnerships often do not need to pay minimum taxes that are required of LLCs and corporations.

The Partnership Disadvantage

  • Individual partners bear responsibility for the actions of other partners.
  • Poorly organized partnerships and oral partnerships can lead to disputes among owners.

How to Choose the Best Business Structure

3.The Limited Liability Company (LLC)

A Limited Liability Company (LLC) is formed by 1 or more individuals or entities through a special written agreement. The contract details the organization of the LLC, including provisions for management, assignability of interests, and distribution of profits and losses. LLC are permitted to engage in any lawful, for-profit business or activity except banking or insurance.

LLC owner(s) can choose to be taxed either as partnerships or as corporations. An LLC can be managed like a partnership (a member-managed LLC) or like a corporation (manager-managed LLC). LLCs can create a board of directors and can have a president and officers just like a corporation. LLC can choose to have periodic meetings of their membership, or they can choose to ignore such formalities altogether.

The LLC company structure is usually chosen by those wishing to run a small business. Companies that wish to pursue funding, accumulate a large number of shareholders, and/or eventually pursue an initial public offering, the LLC is not an option instead of a corporation. Sometimes small companies begin life as LLCs, outgrow the LLC form, and then the LLC’s owners transfer the assets of the LLC to a newly formed corporation with the same owners as the LLC. Thereby, the LLC is converted to a corporation.

The LLC Advantage

    LLCs do not require annual meetings and require few ongoing formalities.

Owners are protected from personal liability for company debts and obligations.
LLCs enjoy partnership-style, pass-through taxation, that’s favorable to many small businesses. Read more about filing as a corporation or partnership and filing as a single member LLC at IRS.gov.

The LLC Disadvantage

  • An LLC is not an appropriate vehicle for businesses seeking to become public eventually, or to raise money in the capital markets.
  • LLCs usually requires annual fees and periodic filings with the state.
  • Self-Employment Taxes. Members of an LLC are considered self-employed and must pay the self-employment tax contributions towards Medicare and Social Security. The entire net income of the LLC is subject to this tax.

 

4. The Corporation
A Corporation is a more advanced company organization. A corporation known as the C corporation has certain rights, privileges, and liabilities beyond those of an individual. Doing business as a corporation may yield tax or financial benefits, but these can be offset by other considerations, such as increased licensing fees or decreased personal control. Corporations can be formed for profit or nonprofit purposes.

An S corporation is similar to a C corporation but you are taxed only on the personal level. Learn more about the S corporations business structure model.

The Corporate Advantage

  • Owners are protected from personal liability for company debts and obligations.
  • Corporations have a reliable body of legal precedent to guide owners and managers.
  • Corporations are the most effective vehicle for eventual public companies.
  • Corporations can more effectively raise capital through the sale of securities.
  • Corporations can easily transfer ownership through the transfer of securities.
  • Corporations can have an unlimited life.
  • Corporations can construct tax benefits under certain circumstances, but note that C corporations may be subject to “double taxation” on profits.

The Corporation Disadvantage

  • Corporations require annual meetings and require owners and directors to observe certain formalities.
  • Corporations are more expensive to set up than partnerships and sole proprietorships.
  • Corporations require annual fees and periodic filings with the state.

5. Trust

A Trust is a legal relationship in which one person, called the trustee, holds property solely for the benefit of another, called the beneficiary.

6. Joint Venture(s)

A Joint Venture is formed for a limited length of time to carry out a business transaction or operation.

7. Tenants in Common

A Tenants in Common allows 2 or more individuals to occupy the same business while retaining separate identities in regard to assets or liabilities as a result of business activities.

8. Massachusetts Trust

A Massachusetts Trust is an incorporated business with the property being held and managed by the trustees for the shareholders. The trustees are seen to be employees since they work for the trust.

Don Briscoe
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Don Briscoe

Finance educator, advisor, and leading voice in the global financial literacy movement.Founder and editor of MoneyPacers.com.He lives and enjoys life with his family in New York.
Don Briscoe
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