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How to Choose the Right Business Structure for Your Small Business

Date: September 17, 2009

The pros and cons of the most common types of business structures to help you decide what's best for your small business.


Opening a New BusinessThinking of launching your own business? Before you choose a location, hire a staff or put the word out about your new venture, you have a bigger decision make: What type of business structure to establish. The most common types of business structures are sole proprietorship, partnership, corporation, S corporation and limited liability company (LLC). When selecting a business structure, it's important to weigh the legal and tax options of each one, and which best fits your business. Here's a breakdown of the most common business structures and what each could mean for you:

Sole proprietorship

A sole proprietorship is owned by one person and there is no legal distinction between the owner and the business. All profits and losses are accrued to the owner, and subject to taxation.

  • Advantages: Sole proprietorships are easy to start up and easy to discontinue because the business owner has full control over the business. Also, the owner takes all profits from the business. It has tax advantages, too: The owner only pays taxes on profits and is not subject to corporate taxes.
  • Disadvantages: The owner is responsible for all the business funds, so raising capital can be difficult. Also, the business owner would be responsible for all debts accrued by the business and other risks that can come with business growth. 

Partnership

In a partnership, owners share the profits and losses associated with the business.

  • Advantages: You don't have to register with the state or pay fees to start a partnership, and filing taxes is easy since you only the partners are taxed, not the business.
  • Disadvantages: All partners are personally responsible for any business debts or liabilities. Plus, if you don't completely trust your partner, a falling-out could wreck your start-up success.

Corporations

Corporations are the most common form of business organization. It's given legal rights as a separate entity from its owner, thus keeping its owner from being liable if the company is sued. Corporations are owned by a group of people known as shareholders.    

  • Advantages: The limited liability of a corporation protects its owners from legal trouble or the business' debts. The corporation pays separate taxes from its owners, so the owners only pay taxes on corporate profits paid to them through salaries, bonuses and dividends.
  • Disadvantages: There is more paperwork associated with making your business a corporation, as well as fees. Some types of corporations are taxed twice: Once on the company's profits and again on any dividends paid to shareholders.

S Corporation

An S Corporation is similar to a corporation, in that business owners have limited liability in the company. However, S corporations generally do not pay income taxes, but rather, the business' income or losses are passed along to shareholders.

  • Advantages: Business owners have limited personal liability as with a corporation, but don't have to pay corporate taxes.
  • Disadvantages: S Corporations can be costly to set up, and there are a number of regulations and requirements that must be upheld.

Limited Liability Company (LLC)

A Limited Liability Company (LLC) is the hybrid of a sole proprietorship and a corporation. Like a corporation, the owners of an LLC have limited liability, but is also shares the pass-through taxation of a sole proprietorship or partnership (meaning, if you own an LLC, you are only taxed once for your business).

  • Advantages: The LLC is a flexible tax structure, allowing owners to decide if they want to be taxed as a corporation, sole proprietor, partnership or S corporation. Also, the owners of an LLC are protected from the acts or debts of the company
  • Disadvantages: It could be more difficult to raise funds for an LLC because some the business structure is fairly new, and creditors and lenders find corporations to be more viable. As a result, some lenders will only lend LLCs money on the condition that its members become liable for the debt of the LLC.

For more information on which business structure suits your start-up, visit the IRS' Business Structures information page.

Photo credit: Monica's Dad

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