You’ll need a good choice of a business structure laid down before registering your business with local, state, or federal governments. Changing to a different business structure over time can be restrictive and expensive.
This is why you should discuss it with a business counsellor, accountant, or attorney. Each business structure has its own advantages and disadvantages.
What is a Business Structure?
Business structure refers to the legal form of an organization that is accepted by a given jurisdiction. It guides or controls the day-to-day operations of a business. It spells out who a company's owner is and how the business shares its profits. It should be chosen with your business in mind and what you require in relation to income distribution, tax management
Despite these advantages and disadvantages, you should make a proper choice on which structure to use. It affects your: Day-to-day activities, how much tax you pay, your ability to raise capital funds, the amount of required legal work, the Risk of personal liability, etc
Types of Business Structure
A sole proprietorship is the simplest business structure. A sole proprietorship is easy to form and gives you complete control of your business. If you plan to work alone, this is for you.
This is because it involves an entity that is responsible for the daily operations of the business. Sole proprietorships can be a good choice for low-risk businesses and owners who want to test their business idea before forming a more formal business.
There are several pros of a sole proprietorship business structure. First, it is cheap to start. When registering a sole proprietorship, minimal costs are incurred. These only costs are business taxes and operating license fees.
Unlike a limited liability company, there's no need to meet requirements such as shareholder meetings and voting or election of directors.
The cons are since it is not a separate legal entity from its owners, the owners will be personally responsible for the debts, liabilities, and commitments of the business. The business assets and liabilities are however not separate from your personal assets and liabilities. Hereby tendencies for Default Risk-the chances of not fulfilling the obligations.
A partnership structure is employed when there are several investors in the business. A partnership however is the relationship between two or more persons to do trade or business. It is the simplest structure for multi-owner companies or professional groups. They come together and contribute money for the smooth running of the business to earn profit.
There are two types of Partnerships
There are several business owners, each actively taking part in the business. All decisions about growth, expansion, and sustainability are being taken collectively. So the liability of the business is also shared between all the partners.
The partners hold an equal role in owning and operating the company as well as liability for its debts, other partners’ actions, or financial obligations.
This structure comprises both limited and general partners. General partners are the decision-makers, and limited partners act like investors. They are not part of the decision committee and hereby have limited control or input into the company.
So limited partners don’t have any liability towards the business, and the only risk they have is the risk of their capital.
A partnership structure is more time-consuming than a Sole proprietorship because of the legalities involved, and it is costly to set. It leads to management issues regarding the partnership agreement. Partnerships are however easy to create and maintain.
According to the Oxford learners dictionary, ‘A Corporation is a large company or group of companies authorized to act as a single entity and recognized as such in law’. It is the most complicated business structure.
This is why most corporations employ attorneys to supervise the registration process and to ensure that the entity follows the state laws where it is registered.
This is how many big organizations are formed. A corporation gives a separate legal entity from its owners. It entails that a corporation's debt is not considered that of its entities. Unlike the sole proprietorship, the creditors are for the business alone and personal assets at risk.
The main types of corporations are C-corporation and S-corporations. A C-corporation exists as a separate legal body from its owners, whereas an S-corporation may consist of up to 100 shareholders and functions in the same way as a partnership.
The biggest benefit for a business owner who decides to incorporate is the liability protection he or she receives. A corporation also can retain some of its profits without the owner paying tax on them. The ability of a corporation to raise money is another gain. Fundraising is extremely easy for a corporation due to the availability of sources by which a corporation can raise funds.
A corporation can sell the stock, either common or preferred, to raise funds. Corporations also continue infinitely, even if one of the shareholders dies, sells the shares, or becomes disabled.
The major con of a corporation is double taxation. Corporate Tax is charged to the organization separately, and when dividends are being divided to shareholders, a dividend tax is also charged. So this creates a huge influence on their personal income. With a large number of persons, the risk of idea leakage is immense.
Limited Liability Company (LLC)
Limited liability companies, often known as "Lacs," have been in existence since 1977, but their popularity among entrepreneurs is a relatively recent phenomenon.
A limited liability company (LLC) is a mixed business structure that combines the best business structures i.e., it possesses the characteristics of both partnerships and corporations. It provides personal liability protection to business owners while reducing tax and business requirements.
The profits and losses of the business are passed through to the owners, and each business owner is required to include a share of the profits/losses in their personal tax returns.
One of the advantages of setting up a limited liability company is that it comes with fewer requirements compared to a corporation. Less paperwork is involved, and the owners enjoy limited liability, which protects their assets from being sold to pay the liabilities of the entity.
A limited liability company is not subject to any limitation on the number of shareholders it can appoint.
On the downside, a limited liability company is expensive to set up since it must register with the state where it intends to conduct operations.
Also, the entity may need to hire an accountant and an attorney to ensure that it complies with tax and regulatory requirements.
Depending on the size and scope of your business, there are various advantages outlined above of any suitable business structure to your business. Your job then is to know which is best for your business.