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Types of Business Structures
 
 

Types of Business Structures

 

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Sole Proprietorships, Partnerships, Corporations, Limited Partnerships and Limited Liability Partnerships, S Corporations and Limited Liability Companies

There are many business types which the entrepreneur may decide to use for their business. Each of them has their own advantages, operational applications, and tax structures. We will go through each of these in detail during this article in order to help make decisions on which business type may be right for you. Your decision will also be based on many factors including liability, control, tax implications, complexity of formation, and capital requirements.

As an entrepreneur the business structure is one of the first major decisions you will make. We will cover the major advantages and disadvantages of each type of business structure. There are five main factors that will influence your decision on which structure to use. These are:

  • Legal liability. This is the amount of risk or potential your business has for liability.

  • Tax implications this includes your business goals and the structured desired to maximize your growth and minimize your tax burden.

  • The level of flexibility this you desire in your ownership structure for both short and long term goals.

  • Future needs for the growth of your company after the startup phase.

  • Administrative time required to ensure your liability protection.

We will discuss the business types, structures, and advantages and disadvantages of each business type as follows.

Sole Proprietorships

Sole proprietorships are the most basic business form. A sole proprietorship is a business owned and operated by one owner who is in total control. In this type of structure the entrepreneur goes into business alone or with employees but without any co-owners. There is only one owner in this situation.

Sole proprietorships are "for profit" businesses with unlimited personal liability. This type of business is managed by the sole proprietor and may be in the format of "Doing business as" DBA such as a woman owner owning a company named "Lily's Dog Grooming". For tax purposes, in the sole proprietorship all income and expense items are reported on Schedule C of the business owners Form 1040. The business is typically funded through a loan to the sole proprietor and is typically the least costly means of starting a business. All of your profits will be considered as income to you and will be taxed as personal income.

These are the advantages of a sole proprietorship:

  • It's easy to establish

  • You have full control of the business decisions

  • You own all of the profits and the headache

  • Minimal legal restrictions

  • No workers' compensation requirements or unemployment taxes

These are the disadvantages of a sole proprietorship:

  • You are personally liable for all the business debts

  • You are wholeheartedly responsible for all the effort to keep the business going

  • You have no employment benefits of the business fails

  • You may have difficulty obtaining financing

General Partnerships

General Partnerships are a legal business form where two or more persons go into business for profit as co-owners and share the profits and losses. A partnership is the association of two or more co-owners carrying on business for profit. Partners have unlimited personal liability for partnership debts. The partnership is managed by the partnership typically though a partnership agreement. This form of business has a pass through tax treatment where all income and expense items pass through to the individual partners on the schedule K-1 tax form. Partnerships may have difficulty raising capital because investors prefer to invest in businesses which are limited liability include the LLC. LLC's are considered the better choice if partnership tax treatment is the goal. The partnership should contain a formal partnership agreement which includes the property each other owns and the method used to disperse profits and liabilities and the requirements for changing partners.

There are two drawbacks to partnerships. First, if one of the partners makes a business mistake without the knowledge or consent of the others, every member of the partnership must shoulder the consequences. Second, if a partner goes bankrupt their own capacity their share of the partnership can be seized by creditors. The partnership Act was passed to set guidelines on partnerships. There is some flexibility in your own partnership by developing a partnership agreement. The main provisions of the Partnership Act state:

  • Unless you are a member of certain professions you are restricted to a maximum of 20 partners in any partnership.

  • No partner shall be paid a salary.

  • All partners contribute capital equally.

  • All partners share profits and losses equally.

  • No partner shall have interest paid on his capital.

  • All partners have an equal say in the management of the business.

These are the advantages of a partnership:

  • Relatively easy to start

  • You have someone to share the workload and responsibilities with

  • You only share your profits with a partner

  • You can more easily obtain along than in the sole proprietorship because you have the income of two partners

 


These are the disadvantages of a partnership:

  • Partnerships may initially be more expensive to start

  • Partnerships are more difficult to dissolve

  • The business may struggle if one partner can no longer participate

  • You have two decision makers

  • Each partner is bound by the commitments of the other partner

  • Both partners have unlimited liability for the business

Limited liability companies and corporations have basic fundamental structural differences shown in this chart.

Limited Liability Companies

Corporate Structures

· Has members

· Has company shareholders

· Optional managers

· Has a Board of Directors

· Optional officers

· Has Officers

Corporations

Corporations are a business form which are driven by bylaws and shareholder agreements. Corporations are the most formal eyes type of business structures. Corporation ownership is typically founded on ownership of shares of stock. There is no limit to the number of stockholders and each stockholders personal assets are protected by the corporation. The bylaws to contain the specific procedures concerning employment positions of the corporation, procedures for the shareholders, and how meetings are held. The shareholder agreements are documents which contain information on the transfer of ownership for shares, how to resolve issues between shareholders, how to establish the price of stock shares and how shares can be bought and sold.

There are many benefits in incorporation. In order to maintain corporate status a corporation is required to do all of these actions:

  • Maintain an official corporate seal

  • Issue official stock certificates

  • Develop bylaws and keep minutes

  • Pay corporate income taxes

  • File for articles of incorporation with the state

Corporations are the most complex business form. There are many different forms of corporations these include general (C) corporations, S corporations, foreign corporations, close corporations, professional corporations, and not for profit corporations.

These are the advantages of a corporation:

  • Has an endless lifespan

  • Personal assets are protected from business liabilities

  • Ownership of a corporation can be changed without affecting the day to day operations

  • It is easy to raise capital through the sale of stock

  • Ownership of the company can be transferred through the sale of stock

These are the disadvantages of a corporation:

  • Incorporation involves larger startup expenses

  • The corporate charter governs activities of the corporation

  • Corporations are subject to more taxes

  • Corporations have more legal formalities

  • Corporations are subject to more Federal laws

General C Corporations

The general business corporation is a very formalized type of business structure. The General Corporation is the most common type of corporation structure. The ownership of a General corporation the shared through stockholders. There is no limit to the number of stockholders it may have and each stockholders assets are protected from creditors by the corporation.

These are the advantages of General C Corporations

  • Ownership of the corporation can change without affecting the daily operations

  • It is easy to raise operating capital through the sale of stock

  • Ownership can easily be transferred through the sale of stock

  • The corporation can live on indefinitely

  • Personal assets are protected from business liabilities

These are the disadvantages of General C Corporations

  • The initial incorporation involves considerable cost

  • Corporations can only participate in activities that are defined in the corporate charter

  • Profits of the corporation are subject to dual taxation

  • Corporations are subjected to additional Federal and state regulations

S Corporations

The S corporation is formed by filing Articles of Incorporation with the Secretary of State. The S corporation will develop bylaws and a shareholder buy-sell agreement. The S corporation has limits on the number of shareholders you can have and the types of shareholders may limit the ability to raise capital. S corporations are limited to 100 shareholders and only one class of stock is permitted. Partnerships and corporations cannot be shareholders.

Many businesses prefer the S corporation structure because it has attractive tax benefits. S corporations avoid dual taxation because all losses and profits are passed through the corporation to the shareholders. Each of the shareholders debts are protected from the business debts. If an S corporation loses money there is often a significant tax benefit to the shareholders. In order to qualify for S corporation status your business must:

  • Already exist as a corporation

  • Issue only one class of stock

  • Have no more than 75 shareholders

  • Have its headquarters in United States

  • Cannot be a financial institution

  • Cannot have more than 25% of the gross receipts from passive sources

 


The requirements for S corporations are very specific and are subject to many IRS regulations. The tax advantage will be lost if the corporation fails to maintain its eligibility. Once the eligibility is lost you cannot be reactivated for a period of five years. These are the issues which can cause your S corporation to be terminated:

  • Its size exceeds 75 shareholders

  • You create a second class of stock

  • You acquire a subsidiary

  • You lose your corporate status

  • Or you transfer your stock to a corporation or partnership

Foreign corporations

As a business owner if your corporation does business outside of the state in which it was incorporated it is considered a foreign corporation. If you begin business in one state as a corporation and later want to do business in another state, your corporation in the initial state will become a foreign corporation.

Close corporations

Close corporations for similar to gentle corporations but have restrictions on their certificate of incorporation. These restrictions include a limit on the number of stockholders, the prohibition against a public offering of stock, and limitations on the transfer of stock outside the corporation.

These are the advantages of Close Corporation:

  • Stock transfers can be restricted so that only the original owners can purchase stock

  • Close corporations can eliminate a board of directors

These are the disadvantages of Close Corporation

  • Make interstate commerce trade difficult due to state regulations

  • Shareholders may have greater responsibilities in the absence of a board of directors

Professional corporations

Professional corporations are limited to individuals who hold a license such as a physician, lawyer, or accountant. Liability is spread to all of the shareholders and the professionals receive a tax benefit.

These are the advantages of a professional corporation:

  • Tax benefits with deferments

  • Protection of personal assets

These are the disadvantages of a professional corporation:

  • The corporation can only encompass a single profession

  • Only licensed professionals can be shareholders

  • Shareholders are liable to one another

  • Shares of stock can only be sold to a licensed member of the same profession

Not for profit corporations

The not-for-profit corporation is reserved for civic, social, or religious groups. Profits cannot be distributed to members of the corporation. The profits are dispersed to support the specific purposes which are outlined in article of incorporation. Nonprofit corporations do not issue stock but are governed by a board of directors.

These are the advantages of a nonprofit corporation

  • Flexibility in business operations

  • Tax exempt status

These are the disadvantages of a nonprofit corporation

  • Cannot merge with other corporations unless they too are nonprofit corporations

  • All of the income must go to not-for-profit purposes

Limited Partnerships and Limited Liability Partnerships

Limited Partnerships and Limited Liability Partnerships use operating agreements which take the place of bylaws and seller agreements. These types of documents address the issues such as membership interests, duties of the members, whether your manager manages the operations, the rights and duties of officers, what type of financial accounts the company will have and what protection managers and employees will have. The limit the liability companies require capitalization upon initiation. LLC's should hold annual meetings of members and managers and the minutes of these meetings should be kept in an LLC book along with financial records and bank account records. A limited partnership is used in a partnership is appealing but you're concerned about the liability with a general partnership in this case you would use a limited liability partnership.

Limited Partnerships

Limited partnerships are appealing because they provide more liability protection than a general partnership. The difference and a general partnership is that in a limited partnership you must always have at least one general and one limited partner.

Here's the main difference:

If you are the limited partner in the business you invest assets into the business and your risk is limited to the amount you have invested.

If you are the general partner you are responsible for the operation of the business and the liability. You are responsible for all of the management decisions and the debt. Your personal assets are not protected from creditors.

These are the advantages of Limited Partnerships.

  • As a limited partner your personal assets or not a risk from creditors

  • The limited partnership is easy to establish

  • It is easier for partnership to get financing than a single individual

  • There is more than one person to share startup expenses

  • Partners share all the profits and benefits

These are the disadvantages of Limited Partnerships.

  • The partnership may be difficult to end

  • The partnership is more expensive to set up initially

  • The loss of a partner may dissolve the business

  • The general partner is exposed to unlimited liability for the business

Limited Liability Partnerships

Limited liability partnerships is another business entity form where partners are given the same liability protection as a professional corporation. A limited liability partnership is a general partnership that provides professional services and is registered as a limited liability partnership.

These are the advantages of Limited Liability Partnerships.

  • The limited liability partnership has less restrictions on capital structure and division of profits

  • Partners of a limited liability partnership have advantages of flow through tax

These are the disadvantages of Limited Liability Partnerships.

  • A sole owner cannot setup the limited liability partnership because the business must have at least two partners to exist

  • There is little legal precedence for limited liability partnerships because it is a relatively new form of business

Limited Liability Company

Limited liability companies are a business structure that combines limited liability provided by a corporation with pass through partnership tax treatment.

These are the advantages of Limited Liability Companies.

  • Owners can participate in the management of the business

  • The limited liability company is easier to operate the corporation

  • Profits and losses go through the company to the owners for tax purposes

  • Personal assets are protected

  • There are no limits on the number of owners

These are the disadvantages of Limited Liability Companies.

  • Limited liability companies are recognized differently in each state

  • Limited liability companies require legal assistance to set up and structure

  • Some professional organizations are prohibited from registering as a limited liability companies such as doctors, lawyers, accountants.

The major factors of business structure and ownership include the control, taxation, and the liabilities. These key factors determine how some business entrepreneurs structure their company. Protection from liability is often a key reason for the selection of a business type.

Business type

Control

Taxation

Liability

Sole proprietorship

The owner has complete control

Is not a separate taxable entity

Has unlimited personal liability

Corporation

Control is distributed among the shareholders

Is considered a separate taxable entity

No liability for the debts and actions of the business

Limited partnerships

General Partners have control the limited partners do not

Is not a separate taxable entity

The General Partners have joint and unlimited personal liability the limited partners have limited personal liability

Limited liability companies

Members share control of the company

Is not a separate taxable entity

Limited personal liability

For tax purposes, state law will control the formation of your business, and Federal law controls how your business is taxed. All businesses are required to file annual tax returns. Sole proprietorships and corporations file income tax returns. Partnerships and S corporations file an information return. Sole proprietors file individual taxes. And, limited liability companies can choose to be classified as a corporation or partnership.

These are some actions you should check as you develop your businesses structure. If you operate as a general partnership you should draft a partnership agreement that outlines business the key business issues. If your business structure will be a corporation you must file the articles of incorporation and pay a filing fee based on the dollar figure of the shares of stock you are authorized. If your business structure is a limited liability company you must draft a business operating agreement and file it with the state. If you operate as a limited partnership you must file a certificate of limited partnership with the state and draft a limited partner agreement.

Summary Reminders and Takeaways

As a business owner an entrepreneur there are many structures under which you can manage your business these include Sole Proprietorships, Partnerships, Corporations, Limited Partnerships and Limited Liability Partnerships, S Corporations and Limited Liability Companies. Each of the structures has their own advantages and disadvantages, operational applications, and tax structures. Your decision for business structure will be based on many factors including liability, control, tax implications, complexity of formation, and capital requirements. As an entrepreneur the business structure is one of the first major decisions you will make. The five main factors that influence your decision are legal liability, tax implications, the level of flexibility, your future needs, and the administrative time you will use to protect your assets. An important part of determining your business structure is protecting your personal assets. The next consideration is typically tax implications

 
 
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