C ongratulations on your new business idea! Now comes the exciting part: Turning your idea into reality. But before you dive into raising capital or creating an organizational chart, one critical decision is choosing the right business structure.
Creating a business structure may sound complex, but the guide below will help you navigate the process. While you may not realize it yet, the structure you choose for your business will affect how you pay taxes, secure financing, and manage your personal risk. Let’s break down the different business entity types to help you pick the best business structure.
What Is a Business Structure?
Think of a business structure as a house. While it isn’t a physical object, it does provide the framework for your business to operate. Additionally, there are different types of structures, each with its own set of rules and benefits.
Choosing the right business structure is like choosing the right kind of house for your needs. A small bakery might not need the same structure as a tech startup planning to go public. This may be because the bakery is small, has few liability concerns, and focuses on local customers. However, the tech company might need a structure for rapid growth, liability protection for the owners, and stock options to attract investors. The choice of structure affects almost everything. It influences how the business complies with rules and how it’s managed day-to-day. So, it’s crucial to align your business’s legal framework with its goals from the very start.
What Factors Should You Consider When Choosing a Business Structure?
There are a few key factors to consider when making this decision:
- Liability. How much personal risk will you have if your business gets sued or goes into debt? Some structures, like LLCs, protect your personal assets, while others, like sole proprietorships, do not.
- Taxes. Different structures are taxed in different ways. Sole proprietors and partners simply report business income on their personal tax returns, while corporations pay taxes on their profits and then shareholders pay taxes again on any dividends they receive. (Simply put, taxation is different for S corporations than for C corporations.)
- Management. How you want to manage your business also plays a role. Sole proprietorships are simple and have one owner who calls the shots, whereas corporations have a more complex structure with a board of directors and officers.
- Growth potential. If you plan to raise money from investors or go public someday, a corporation might be the best option. For smaller businesses, another structure might be a better fit.
Understanding your preferences for each of these factors will guide you in selecting the business structure that best aligns with your plans.
Let’s Explore Some Common Business Structure Options
Understanding the different business entity types available to you is crucial for anyone starting a company. Each entity type offers distinct advantages and disadvantages, depending on your needs and goals. Choosing a business entity involves evaluating factors such as liability protection, tax considerations, and how much regulation you want to handle. Let’s explore some of the most common business structure options.
Sole Proprietorship
Sole proprietorships are the simplest and most common structure. They are ideal for one-person businesses with low-risk and limited growth plans. The owner is the business, and all profits and losses flow through their personal tax return. However, the owner also has unlimited personal liability, meaning their assets are at risk if anyone sues the business.
Partnership
This is a good option for two or more people who want to co-own a business. Partners share profits and losses according to a predetermined agreement. There are two main types of partnerships: general partnerships, where all partners have unlimited liability, and limited partnerships, where some partners have limited liability. Unlimited liability means that the general partners are personally responsible for all business debts. This can put their personal assets in danger. In contrast, limited liability means that liability is restricted to the amount of money that the partners have invested in the business.
Limited Liability Company (LLC)
This popular structure offers a good balance between flexibility and protection. LLCs have limited liability, so the owners’ personal assets are generally protected. The members of an LLC can also choose to be taxed as a pass-through entity, where profits and losses pass through to the owners’ personal tax returns, similar to a sole proprietorship or partnership.
Corporation
This is the most complex structure, but it offers the most protection for owners. The two most common corporation forms are C corporations and S corporations. However, there are many others, such as:
- Professional corporations—designed for licensed professionals
- Public corporations—whose shares are traded publicly
- Close corporations—which typically have a limited number of shareholders
A C corporation is the traditional corporation structure. C corporations are legal entities separate from their owners, and shareholders’ personal assets are protected from business debts and lawsuits. However, income from C corporations may be subject to double taxation. This means that the corporation pays taxes on its profits, and then shareholders pay taxes again on any dividends they receive from the corporation. C corporations also have more complex filing requirements and ongoing formalities, such as holding board meetings and maintaining certain corporate records.
An S corporation is a special type of corporation that elects to be taxed differently from C corporations. S corporations are similar to LLCs in that they prevent double taxation. Profits and losses pass through to the owners’ personal tax returns, similar to a sole proprietorship or partnership. However, there are stricter ownership restrictions for S corporations. For example, S corporations can only have a limited number of shareholders (usually 100 or less), and they must be U.S. citizens or permanent residents.
Nonprofits
A nonprofit is a legal entity formed for charitable or social purposes. It is exempt from federal income tax and may also be exempt from state and local taxes. There are distinct types of nonprofit organizations, including public charities, private foundations, and social clubs. To qualify for tax-exempt status, a nonprofit must meet certain IRS requirements.
The structure you choose for your business will affect how you pay taxes, secure financing, and manage your personal risk.
Set Up Your Business for Success with Bizee
Choosing the right business structure is a key step in launching your business. By considering your options and your specific needs, you can make an informed decision that will help your business thrive. Additionally, the U.S. Small Business Administration offers a great resource to help you choose the right structure. Once you decide, Bizee will guide you through the formation process step by step.
Remember, you can always call our support phone number for further assistance. Now, go forth and make the world a better place with your new business!
Disclaimer: Bizee and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.
