Because you need money to make money
In the first six months of 2022, 2.5 million new business applications were filed in the United States. Whether you’re an independent contractor or a business guru, you may be looking to branch out and start your own company.
Either way, you’ll begin by researching different business types to find the right one for you. We’ve got you covered. Consider the differences, pros, and cons between a sole proprietorship, partnership, limited liability company, and corporation. Additionally, we offer some useful financing options for your new business.
One popular type of business structure is a sole proprietorship, especially for small businesses. It is the simplest business structure because it is run by a single owner. A sole proprietorship is not a legal entity, meaning that the owner has not filed any paperwork to create a separate business entity. This makes it relatively easy and low-cost to establish a sole proprietorship.
However, it also means there is no legal distinction between the owner and the business. As a result, the owner assumes personal responsibility for all liabilities and debts the business may incur.
A sole proprietor business does not file a tax return. Instead, the profits and losses are reported on the owner’s personal tax return as pass-through taxation.
| Pros | Cons |
| Complete ownership and flexibility | Owner is completely liable and assumes potentially unlimited risk |
|
All profit is allocated by the owner |
Owner’s personal assets are not distinguished from business assets |
| Few requirements and restrictions | Ownership is hard to transfer |
| Relatively low-cost and easy to set up | Difficult to raise money or obtain investors |
Businesses that have more than one owner are classified as partnerships. With a partnership, each of the owners will invest in the business and share the profits and losses.
Similar to a sole proprietorship, partnerships are also relatively easy and low-cost to set up. When creating a partnership, the members will sign an agreement that outlines their respective roles, responsibilities, ownership percentages, management rights, profit and loss sharing, and dissolution terms.
Additionally, there are different types of business partnerships, including limited partnerships (LP) and limited liability partnerships (LLP). In an LP, one owner has unlimited liability while the other owner is limited in their liability. This means that the owner with limited liability has less control over the business. However, the owner with unlimited liability may assume the responsibility for potential business debts.
Conversely, in an LLP, all owners have limited liability. With this structure, all partners are protected from potential business liabilities and debts. When setting up an LLP, the owners will need to submit a certificate of partnership to the state.
Profits and losses are reported on personal tax returns by all the owners. The amount reported will depend on the profit-sharing percentages stated in the agreement.
|
Pros |
Cons |
|
Shared resources and capital |
Risk of disagreements |
|
Relatively low-cost and easy to establish |
Each partner assumes complete responsibility and liability |
|
Teamwork and shared responsibility |
Partnership ends if one partner leaves |
Amongst the different types of companies, you may choose to set up a limited liability company (LLC) to take advantage of the benefits of sole proprietorships and partnerships. LLCs are separate legal entities that need to be registered with the state. Additionally, LLCs require operating agreements that outline the owners’ rights and responsibilities, profit and loss allocation, buying and selling provisions, company dissolution process, and management structure.
Although this can be a lengthy process with high costs, it mitigates the liability for the owners. In the event of a lawsuit or debt, the owner's personal assets will not be seized or affected. Additionally, profit and loss are reported on individual tax returns. However, some states may impose additional taxes, such as self-employment tax.
|
Pros |
Cons |
|
Limits liability for company owners |
Limited by state laws |
|
Profits are shared amongst owners without double-taxation |
High costs for legal and filing fees |
|
An unlimited number of members |
Owners are not personally liable |
Corporations are the most complex type of business due to the way they are formed and taxed. Corporations are separate entities, making them independent from the owners or shareholders who run them.
First, the corporation must be registered with the state. Second, the corporation must submit an article of incorporation that outlines the business name, structure, purpose, shares, value of shares, directors, and officers. Finally, the bylaws and resolutions must be created. This is an internal document that defines how business decisions are made and the shareholders’ responsibilities.
There are several types of corporations that each offer their own distinct qualities. Here’s a breakdown of the different types of corporations:
The default type of corporation is a C corp. A C corp is managed by a board of directors who oversee the business and establish regulations for its governance. Ownership of a C corp is divided amongst shareholders who each own varying shares of company stock. As a result, shareholders invest in the corporation by buying stocks and receive partial decision-making responsibilities. Nevertheless, a C corp has heavy oversight by the board of directors.
A C corporation is a separate legal entity, meaning the shareholders are not personally liable. Additionally, since C corps are larger entities, the business is not affected if a shareholder leaves.
C corporations pay corporate income tax on the profits made by the business. However, the shareholders also pay personal taxes on the income or dividends distributed to them. As a result, C corporations are doubly taxed.
A type of corporation that can help you avoid double taxation includes an S corp. Instead, the profits and losses are passed on to the shareholders. As a result, S corps avoid corporate income taxes on profits and losses.
To be recognized as an S corp, the business must file for a status change with the IRS. This filing process is in addition to registering with the state and submitting the articles of incorporation. To be eligible for S corp status, the corporation must
Unfortunately, not all states recognize S corporations. As a result, the business will be treated as a C corporation within these states and taxed accordingly. In these cases, S corporations may be liable for income, estimated, employment, and excise taxes, while S corp shareholders may be liable for income and estimated taxes.
Also called benefit corporations, B Corps are for-profit businesses that produce a public benefit. As a result, these corporations differ from C corps in their purpose, accountability, and transparency. Most states require B corps to complete annual reports that outline their benefits and contributions to the public. Currently, only 35 states allow B corporations, and each state has its own criteria for what qualifies as a social benefit and how to report it. As a result, this makes it more difficult and time-consuming to establish a B corp.
Despite the differing purpose, B corps are taxed in the same way as C corps. Similarly, shareholders also have limited financial and legal liability in B corps.
These corporations are tax-exempt, allowing them to circumvent all state and federal income taxes on profits. This is because nonprofits are primarily involved in charity, educational, literary, scientific, or religious work. As such, nonprofits provide more benefits to the public than B corp.
Like an S corp, corporations seeking nonprofit status must file for an exemption with the IRS. If granted nonprofit status, these businesses must follow stringent guidelines, such as refraining from distributing profits to political campaigns or members. Instead, the profits must be reinvested in the nonprofit to continue its charitable purpose.
Nonprofits offer limited liability to their members; however, these individuals are subject to more oversight by state and federal laws.
|
Pros |
Cons |
|
Owners are not personally liable |
Rigorous and costly process to establish corporation |
|
Can be transferred relatively easily |
Double taxation (except for nonprofits) |
|
Personal assets cannot be seized |
High oversight |
After understanding the different types of business ownership and picking the right one for your company, the next step will likely be financing the operation. Like the different forms of business ownership, there are also several options for funding your new company.
The most common type of funding is commercial business funding obtained through a traditional bank or financial institution. The money can be used towards various operational needs, such as purchasing equipment, covering manufacturing costs, or payroll. Since a commercial loan can be used to finance various business expenses, sole proprietorships, partnerships, and limited liability companies utilize them most often.
Typically, the maximum commercial business loan is $500,000 with a repayment term of up to five years with interest between 7% and 30%. However, there are some requirements to meet when applying for a traditional business loan. including years in operation and a minimum credit score.
On the other hand, corporations may raise funds by going public and selling shares of the company stock to investors. This is known as equity financing, which helps these businesses secure funds for short-term needs.
Typically, investors will include venture capitalists and angel investors. In exchange for purchasing shares in the company, the investors will gain ownership rights. Nevertheless, the funds obtained from selling shares in the corporation do not need to be repaid.
When starting your own company and creating a business plan, you’ll likely need to define the ownership structure. If you’ll be running the company independently, you’ll likely start as a sole proprietorship. If you’re starting a company with a close friend, family member, or business associate, you’ll probably opt for a partnership. As you grow, you may transition to a limited liability company or corporation with more favorable liability protection.
Before settling on the type of business ownership you’ll adopt, consider the personal liabilities and tax structure associated with each.
