Congratulations, you have decided to move forward and start a business. Now, it’s time to choose a business structure. A business structure will determine many things, including what options are available to the business and what direction the business will take in the long run. There are three main types of business structure. Today, I will identify the three main business structures and some pros and cons of each type.
Sole Proprietorship
A proprietorship is easy to start and easy to dissolve, if needed. Generally, an individual starts a proprietorship when they open a small shop. The ease of starting a proprietorship makes it one of the most commonly used business structures for new small businesses. Starting a Proprietorship in most American states does not require any type of registration other than a local business license. A proprietorship can also bring some tax advantages, like business deductions on a personal tax return. This is done by filing a Form Schedule C with the standard 1040 form. Although proprietorship is easy and relatively cheap to start, some downsides should also be understood.
One major disadvantage is that a proprietorship makes raising start-up capital from outside sources challenging because this structure only allows inside ownership. This means investors will not be attracted to invest in the business. Additionally, banks are reluctant to give business loans to a proprietorship, as proprietorships are smaller, which poses a greater risk for the bank. This makes the risk too great for the bank.
Another area for improvement with this structure is the lack of differentiation between the owner and the business. Both entities are considered the same, which can be tricky for several reasons. Firstly, the owner is personally liable for any issue during business. If the business gets sued, the owner is the one being sued. If the business loses the lawsuit, the owner has to pay the total loss. Secondly, there is no distinction between the business and the owner’s finances. This means the owner is personally responsible for all taxes and fees associated with the business. A Sole Proprietor is on the hook for paying the self-employment and the employee taxes out of one income. Proprietorships are easy to start but represent a higher risk for banks, resulting in more personal risks.
Partnership
A partnership is when a group of people come together to pool resources to start a business. There are two major types of partnerships: general partnerships and limited partnerships. A general partnership is when all partners manage the business together. This also means that the partners are responsible for the business’s day-to-day operations. On the other hand, a limited partnership is when partners pool their resources like the general partners, but they are more like investors. Limited partners have no control over the day-to-day operations of the business.
Partnerships offer some benefits that are not available to Sole proprietorships. The main benefit is limited liability protection, which means the owners are only partially liable for damages when the business is sued. The partners are only liable for damages that are equal to or less than their share of the investment of the company. For example, Bob puts in $10,000 to start a local store set up as a partnership. The store sold a product that injured someone. The injured party sued the store for $1,000,000. Bob is only responsible for $10,000 in damages if the store loses the lawsuit. The other partners are responsible for res per their investment in the business. A partnership protects individuals from some liability in the ordinary course of business.
On the other hand, any general partner can take out loans and sign for anything in the business’s name. This may create a financial obligation that the other partners are unaware of and that the company cannot support. A Partnership is more expensive to start than a sole proprietorship because the business needs to be registered by your state’s sectary of state. An attorney is required to file the paperwork. Although partnerships require excellent planning and clear communication with other partners, it is a good business structure.
Corporation
It is relatively complex and expensive to establish a corporation. A corporation is a business that is wholly separated from its owners. This means the business is its own entity in the eyes of the law. So, the business owners are not liable for any debts or other issues that this type of business may have. Another benefit is that corporations have a much easier time finding starting capital. This is because a corporation can sell stock. Also, banks feel more comfortable loaning to corporations than other business types. Lastly, since a corporation is its separate entity, even if the owner is unable to work, the business can still continue. Although corporations offer a lot to business owners, they also have downsides.
Corporations have a couple of significant downfalls that may make them not the best choice for new business owners. The first corporations are expensive and very complex to start and run. For example, to establish a corporation, an attorney must complete and file the application with the government for review. The second issue that is common is the chance of double taxation occurring. This can happen when the corporation’s income is taxed, and the dividends that the corporation pays out to owners can also be taxed. Like the other business structures, corporations have benefits and downsides.
Conclusion
Each business structure has its pros and cons. Each business structure is like a toolbox full of tools. To correctly complete a job, you need the proper tool. Depending on the business owner’s situation, the type of business they want to engage in, and personal preference are all factors that must be addressed before choosing a structure.