On average, about 4.4 million new businesses are started every year.
There is a lot that goes into it, so if you want to start a business, you should be prepared from the beginning. There are all kinds of things that you need to be aware of. One of the most crucial is the type of business structure that you should use.
In this guide, we’ll cover the different business structures that are available. You’ll then know which is best to help you reach your long-term goals. Keep reading for more.
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The Importance of Long-Term Goals
Before you create a business, you should have your long-term goals in mind. If you don’t, then what are you working toward?
With clearly defined goals, you’ll have something to aim for throughout the entire process of starting your business. They’ll shape every decision you make, and having these goals from the beginning will help you stay on track.
Your long-term goals will help you dictate your short-term goals, and they’ll serve as motivation on your journey. You’ll run into difficulties when getting your business going, but knowing what your goals are will remind you of what you ultimately want to achieve.
What Is a Business Structure?
A business structure is also known as a business legal structure or business entity. It’s a government classification that determines various elements of your business.
There are certain aspects on a federal level, and others on a state level. This includes things like tax burdens and liability ramifications.
Why Is a Business Structure Important?
When starting a business, you must choose the right structure. It will affect several important factors about your company and how you need to operate it.
With some business structures, all business income is categorized as personal income. For others, business income and personal income are separate.
The tax rates for personal income and business income are different. As such, your tax burden will vary depending on the business structure you go with.
You might face a lawsuit at some point down the line. If your business is an LLC (limited liability company), your personal assets will be protected.
It’s important to note that LLC structures are only recognized at a state level – not at the federal level. The federal government does, however, recognize C corporations, and these offer the same liability protection as LLCs.
There are different tax forms for each business structure. This means you’ll need to submit different forms depending on the structure you choose.
Corporations, for example, need to submit articles of incorporation as well as regular government reports. It’s possible to use a fictitious name for a business partnership, but if you do this, you’ll also need to submit special paperwork.
The hierarchy of a company can vary a lot. Corporations, for example, require a board of directors, and they need to meet a certain number of times each year in some states.
If a corporation owner leaves the company or transfers shares, the hierarchy prevents business closure. This also applies if the founder dies. This is the only structure that offers this protection.
When registering your business in your state, you need to provide a business structure. You won’t be able to apply for an EIN (employer identification number) without one. It’s also a prerequisite for getting all the licenses and permits that you need.
You may want to raise funds at some point, and your business structure will determine how you’re able to do this. Offering stocks, for example, isn’t possible with sole proprietorship – it’s typically only corporations that can do this.
What if You Pick the Wrong Structure?
You shouldn’t make this decision until you’re certain of the structure that you need. This will affect a range of aspects of your business, so doing things right is vital.
If you need to, you can change your business structure further down the line, but it’s often a very difficult process. It’s confusing and disorganized, and can cause certain tax consequences – it may even result in the closure of your business. It’s much better to make the right decision at the start to save yourself from trouble later on.
Types of Business Structures
There are several types of business structures available. You need to consider where your business is starting, as well as where you want it to end up so that you can pick the right structure.
This is the most basic business structure you can go with. Many people starting a business on their own go with this as it involves just one person being responsible for the entire company.
This is typical of people who want to start a small business, such as some form of digital service or a business they can run from home. The costs of starting a sole proprietorship can vary depending on a range of factors. Some typical expenses that people need to consider when first starting include:
- State and federal fees
- Equipment leases
- Banking fees
- Office space
- Professional services your business contracts
Sole proprietorships have been on the rise in recent years. This is because they’re ideal for people offering services such as bookkeeping, graphic design, web development, social media management, and more. These kinds of online businesses have become very popular, and will likely continue to grow in the coming years.
Other businesses that may use this structure include things like cleaning services, babysitters, photographers, and private tutors. Small businesses that consist of just one person are often best set up as sole proprietorships.
One potential problem here is that when you operate as a sole proprietorship, your personal and professional assets aren’t considered separate. This means that if you face a lawsuit, these assets won’t be protected. This isn’t often an issue during the early stages, but as a business grows, the risk could increase.
Benefits of a Sole Proprietorship
A sole proprietorship is very easy to set up. You won’t have much paperwork to do as you’re the one handling all aspects of the business. While the costs vary by state, it’s generally one of the cheaper structures to use with licensing fees and business fees being the only fees you need to worry about.
There are various sole proprietor tax deductions available. You’ll be able to enjoy these because you and your business are considered a single entity.
If you need to end the proprietorship, it’s fairly simple. You won’t need to do any formal paperwork as you’re the only person involved in the business.
A business partnership could be a good choice if you’re opening a business with two or more people. There are two types of these to choose from.
A general partnership means that everything is evenly shared. With a limited partnership, one person will control all operations, and any other partners will contribute to, and receive, a portion of the profits.
You can run a partnership as either a sole proprietorship (partners and businesses are the same entity) or an LLP (limited liability partnership). This will depend on the liability structure and funding available.
People often choose to form a partnership when going into business with a friend, relative, or business partner. This is fairly typical of small businesses such as agencies or restaurants. The partners share things like decisions, profits, and losses.
It’s important to remember that each partner will be held liable for the decisions of themselves and the others. Partnerships tend to cost more than sole proprietorships, but the cost can still vary. You should have an attorney review your partnership agreement which you will need to pay for.
Benefits of a Partnership
While these can be slightly more difficult to form than sole proprietorships, it’s still a relatively easy process. Your state might require that you operate under a fictitious name (e.g., doing business as/DBA). In this case, you’ll have to file a Certificate of Conducting Business as Partners as well as an Articles of Partnership agreement which will incur some added costs.
By having multiple owners, you’ll have an easier time obtaining a business loan. You’ll have two (or more) credit histories that bankers can consider; this is especially useful if you don’t have a good credit score.
You’ll need to file federal tax form 1065 stating your returns, and you generally won’t have to pay income tax. All partners need to report shared income/loss on their tax returns. If the partners agree that someone has brought the most seed capital or made higher contributions to the business, they may keep a higher share and be considered the majority owner.
A limited liability company has some characteristics of a partnership, with the added benefit of personal protection. It offers the same tax and flexibility perks of a partnership and members are protected from personal liability.
Note that members won’t be protected if they acted in a wrongful or negligent manner that caused injury to someone else working within the business.
This structure allows earnings and losses to be considered income on the owners’ personal tax returns, while providing them with liability protection. As you may expect, these are generally more costly to set up than partnerships.
You can set up a small business as an LLC, but the structure is more typical of larger businesses. Accountants, tax firms, and law firms often choose this structure, as well as many other types of companies.
A corporation is a completely separate entity from the owners. This means that the owners and the business have independent legal rights. The business can own and sell properties, be sued, sue others, and sell stocks (ownership rights).
The fees vary by state, but this is usually a fairly expensive structure. There are several types of corporation structures:
- C Corporations
- S Corporations
- B Corporations
- Closed Corporations
- Open Corporations
- Nonprofit Corporations
Benefits of a Corporation
As the business is separate from the owners, they have liability protection. This will keep their personal assets safe if the company gets sued.
The transfer of shares or death of an owner won’t affect the operation of a corporation. It will continue to function which is ideal for creditors, investors, and consumers. A corporation can also raise capital much more easily from multiple investors.
This type of business is owned by the people it serves. The user-owners (members) benefit from the company’s offerings and make decisions about the direction of the company. They also receive a share of the profits.
Benefits of a Cooperative
A cooperative may be able to obtain increased funding in the form of federal grants. They can also leverage their business size to provide members with discounted products and services.
Factors to Consider Before Choosing a Business Structure
Sometimes it’s easy to determine which structure would be best for a business, but in other cases, it can be difficult to decide. There are several things you should take into account to figure out the best choice for your business.
Think about where your company is going and what structures will best support reaching the destination. Consider the growth and change that may occur, and how certain structures could impede this.
You might want to keep things simple, especially if you’re starting a small business. In this case, something like a sole proprietorship or a partnership may be best. Just make sure your choice can support your other business needs.
Facing a lawsuit is never ideal, but if it happens, protection from personal liability will be beneficial. This may make you lean towards an LLC.
If you want to be in control of everything, a sole proprietorship may be best. If there are others involved, you’ll want to go with a different structure.
If you need to raise capital from investors, a corporation can be the most suitable choice. It’s much easier to raise funds, and there are various ways you can go about it.
Licenses, Permits, and Regulations
Depending on the nature of your business, there could be various licenses and permits you need to obtain. You should look into the specifics of this for your industry and state to determine what you’ll need to do. This may affect your choice of structure.
The Right Business Structure for You
When starting a new company, figuring out the best business structure to go with can be difficult. You need to consider all the factors above and make sure you look into how things are for your state. When doing this, always keep your long-term goals in mind so that you can make the best decision for the future of your business.
For more business-related articles, check out some of our other blog posts.
Last Updated on March 9, 2023