Why Choosing A Business Structure Matters
Let’s jump straight to the point – the business structure you select determines how you run your business. It is one of the most important decisions you have to make when starting a business. And you have to make it before you even make your first transaction. This shows just how important it is to pick the right business structure for your case.
In this article, we’ll go over the most common business structures and explain the pros and cons of each of them. We’ll give you actionable tips and tricks you can use to make the right decision and start your business on strong foundations.
|Starting a business is hard. You have to make a lot of important decisions that will determine the success of your company. You also have to take care of all the paperwork that goes into registering the business. We recommend you use expert LLC forming services when starting your business to simplify the process. Not only will you save time and money, you’ll also ensure your company stays compliant while you worry about your day-to-day business operations that will help you grow your business. Leave the formation to experts while you worry about other things that matter for your business.|
Why does your business structure matter? For starters, it determines how much you’ll pay in taxes. This is one of the most important things for all businesses. It affects your bottom line and has a direct impact on your profits. But, taxes aren’t always bad. Because you’re paying your taxes, you have more protection if something goes wrong.
Your business structure also determines how much control you have over your business. Do you always want to be the only person in charge? Or are you willing to add people to the leadership team?
Another thing you need to consider when choosing your business structure is your funding. Do you plan on raising venture capital? Or do you want to bring in investors to your business? If that’s the case, you need to go with a formal business structure that allows for outside capital to be injected into your business.
You should also look at your exit strategy when picking a business structure. Most startups have an exit strategy as soon as they launch to the public. If your plan is to eventually sell the business, you have to pick a business structure where changing ownership is easy. Not only will this allow you to sell, but it will also make the whole process a lot smoother.
The complexity of your business also determines the business structure you have to pick. It’s hard to imagine running a business with hundreds of people as a sole proprietorship. Formal business structures are always the go-to option if you have complex operations and many people working in the business.
As you see, there are a lot of questions you need to answer when picking your business structure. It really is one of the most important decisions you have to make when starting a business. Can you change your structure later? In most cases, yes. But that just means a lot of paperwork and legal fees. It’s always best to start with the right structure to avoid the hassle of changing the legal structure of your business down the road.
Remember, the best businesses start with the right foundation. Your business structure is an important element of your foundations.
Business Structures In Different Countries
The information we’ll provide in this article applies to the United States. Why did we choose this option? The answer is simple – most information you can find about business structures online is for the US. Because of the popular media and cultural influences, people all over the world can relatively easily understand the differences between different business structures if we use examples from the US.
But it’s important to note that each country has its own rules and regulations when it comes to business structures. We have different words describing basically the same business structures even amongst English-speaking countries.
Europe is interesting when it comes to business legislation. You have country laws in every EU member, and you have EU legislation that sometimes applies to the businesses in individual countries but not always. You also have to register a European Business Structure if you plan on operating across different EU countries.
Asia is also different. It’s a desirable continent for businesses due to strong economies like Japan, South Korea, China, Singapore, and others. There’s no Asian governing body like it is in Europe, which means you’ll have to turn to specific countries for legislation.
We believe that the information we’ll share in this article will help you make the right business structure selection, no matter where you reside or plan on registering your company. We’ll try to keep the information as general as possible to be easily transferable to your individual situation. But we absolutely recommend that you check your local laws and regulations before you decide to register your company.
Define Your Goals And Work Backwards
There’s a lot you need to know if you want to choose the right business structure for your company. A simple trick we suggest you use is to first define your goals and work backward to find what works best for your organization.
Think about what you want your business to look like in five years. How many employees do you want to have? What kind of responsibilities are you comfortable with? Do you want to leave the company to your kids in decades? Will you bootstrap the growth, or will you bring in venture capitalists?
Once you have a clear vision of your company, you can start analyzing individual parameters to help you pick the right structure. We will go into detail about every structure and show you the pros and cons of each one. This will help you compare what each structure allows you with what you want your company to achieve. By doing this, you’ll uncover the best business structure for your company.
This might seem like a lot of work. But picking the business structure is an important decision, and you should spend your time analyzing your options. This will ensure you make the right pick and start your business on strong foundations that will help you grow your business and achieve your goals.
The Benefits of Outsourcing Business Registration
Ok, so you’ve decided to start a business. You start searching state and federal sites for the paperwork you need to prepare and… you give up. We don’t blame you. With all the different papers you need to fill and create, it’s easy to get discouraged before you even start.
But, there’s an easy solution that can get you going in no time. We suggest you outsource your company formation to experts. We live in a time where you can hire expert agencies to do all the heavy lifting for you.
They’ll ensure that the business name you picked is available before you file for registration. The last thing you want is for your application to be denied because you picked a business name that’s already taken. We suggest you take full advantage of our business name generator. You can generate hundreds of interesting name ideas for your company. The business name generator will even tell you which names have available domains.
Business filing companies will also verify your Articles of Organization and all other required paperwork you have to submit to the state when registering your business.
They will also help you stay compliant with regulations. As a business owner, you have to file annual reports on specific dates if you want to avoid fines or even losing your business. Keeping track of all the documents and compliance requirements can be hard, especially if you also have to run your business.
If you outsource this type of work you ensure you’re company stays compliant while you can worry about your day-to-day operations.
We created a list of companies we trust when it comes to registering a limited liability company (LLC). We even ranked the top LLC formation companies on the internet. We analyzed their costs, reliability, usability, features, and included user reviews and expert reviews. We did this to help you pick the best LLC formation company for your needs.
By picking any of the companies we recommend, you can be sure you’re getting a reliable partner that will help you get your business started in no time.
The best LLC formation company we recommend is ZenBusiness. You can read the detailed review about everything this company has to offer. You can also try Stripe Atlas or Incfile.com if you want something different.
As you see, outsourcing the work you need to do when forming an LLC company can not only save you a lot of time, it can also save you money by helping you avoid fees and penalties you might otherwise get if you don’t stay compliant with all the state and federal legislation. We recommend you outsource as much work as you can if you can afford to.
The Most Common Business Structures
This type of business structure is perfect for those who want to be their own boss. Since it’s run by an individual, it isn’t formally organized. This is one of the easiest forms of structure, and the owner is in complete control. Being a sole proprietor means that there is no separation of personal and business assets. This could become an issue as your business grows. There is no legal distinction between the owner and the business. You are the business, and the business is you.
Depending on which market your company is in, the costs may vary. Your early expenses are mostly fees, taxes, equipment, office space, or any service you might need as a company.
When it comes to taxes, a sole proprietor files taxes under his own name. He’s also liable for anything that happens with the company. Since the owner is the only one who runs this company, all business assets and liabilities are on him. The owner is responsible for the debts and obligations of the business. Getting money for your company is also a different story since it can be hard to raise money. You can’t sell stocks, and the banks are also hesitant to lend money to sole proprietors. Some of the best examples of sole proprietorship businesses are freelance writers, cleaning services, tutors, or babysitters.
As for any structure, there are pros and cons. Here are some of those:
- Simple setup: As we said earlier, this is one of the easiest structures to set up. If you’re the only one who works at the company, this is the best way to do your business. You don’t even have to come up with a trade name; you can work under your own name. There’s little paperwork and what’s also great is that you don’t have to answer to a boss.
- Your own boss: If you have no boss to answer to, you get to be in charge of all decision-making and costs. And what’s best is that you don’t get to split the profits amongst anyone but yourself.
- Low cost: Depending on which state your business operates in, your costs may vary. The only fees that are connected to a sole proprietorship are license fees and business taxes.
- Tax relief: Since the owner and the business are one and the same, any income earned from the company is also income earned by the owner. This means there is only one income tax for both – the owner and the business. If the state taxed them both, this would mean double taxation.
- Easy to quit: Opening a business as a sole proprietor is easy, and the same is with closing it. If you choose not to have a company anymore, you can easily do so. No paperwork is required. All you have to do when closing the company is to pay off all debts and close all accounts. Don’t forget to notify the authorities so you don’t keep paying taxes.
- Personal liability: Everything that happens with your business is on you. As a sole proprietor, you don’t have any protection from liability since the owner and the business are the same thing.
- Uncertainty: If something happens to the owner that makes him incapable of running the business, it’s the end for the company. If a sole proprietorship does not have someone to run it, it’s game over.
- Financing: You’re in charge of the finances. All working capital of your business is limited to whatever funds you’re personally in possession of. Of course, you can obtain finances through loans, but that is a debt to the bank, which most sole proprietors aren’t fond of.
When to use:
A sole proprietorship is a good way to “test the waters” before jumping into a different structure. Many of the larger companies started as sole proprietors. If you’re thinking about registering a sole proprietorship, you need to know when it’s appropriate to use it. First of all, your company must have a very low risk of financial loss and have a low chance of liability. Sole proprietorship is appropriate if your company has a smaller customer base. People often use sole proprietorship when they start a company from a personal hobby.
Having a business in this entity means there are at least two owners. A partnership can be divided into two types: general partnership (everything is shared equally) and limited partnership (one partner is in control, others contribute to the business and receive part of the profits). This structure is perfect for those that want to go into business with their friends, family, or business partner. It allows them to share profits and losses and make decisions together. All partners are held responsible for decisions, losses, and profits made.
This type of business structure is a perfect choice for those who have a partner with experience. An experienced partner can deliver knowledge and skills.
Being in a partnership costs more than being a sole proprietor. You’re going to have to hire an attorney to go over the partnership agreement. You have to establish a win-win situation in order to have a successful partnership.
- Simple set up: The same as a sole proprietor, a partnership needs little paperwork to file. To run a business in partnership, you usually need a business license.
- Growth potential: Banks are more fond of partnerships than of sole proprietors, so there are better chances of getting a loan. There’s also a chance of more business opportunities since you share the workload.
- Sharing the business: Not being the only one employed in the company means you can share your workload with your partner, thus making tasks done quicker and more efficiently. The same goes for knowledge and experience. Let’s say one of you is better at marketing, and the other is better at finances. What can be better than not having to deal with something you’re not good at.
- Costs: Entering a partnership doesn’t just mean sharing the workload. It also means you’re going to be sharing the costs of running the business. Sharing costs can reduce some of the pressure you might feel as a sole proprietor.
- Disagreements: In any partnership, there are disagreements. The main thing is knowing how to manage them. To avoid being in a constant disagreement, discuss the matter in a calm tone and try to come to an agreement or negotiation. If the disagreements become unmanageable, discuss your options of leaving the partnership.
- Individual taxation: While everything else in partnership is divided by the number of partners, taxation is not one of them. Taxes, being in a partnership might cost more than being on your own.
- Shared profits: Everything in partnership is split, including the profits. It has to be done in order to keep the business running. Depending on the shares partners own, there’s a difference in how much profit each of them will get.
When to use:
Choosing to go to a partnership with someone is something to think about. You need to weigh all the pros and cons before jumping into it and then regretting it. Suppose you have a business idea that has a good chance of succeeding, but you just don’t have enough resources to start it. In that case, a partnership is a great idea, especially if your partner has business experience.
LIMITED LIABILITY COMPANY (LLC)
This type of structure is a hybrid and allows owners or partners to limit their personal liabilities. It combines the legal protection of a corporation but has the flexibility and taxation advantages of a sole proprietor or partnership. Members are protected from personal liabilities for everything that might go wrong with the company if it cannot be proven they acted wrongfully.
- Limited liability protection: Members of the company are legally distinguishable between their personal assets and business assets. If the company has debts, your personal assets will not be affected. LLC shields assets of its members, so the only assets to be affected by a creditor are business assets.
- Tax flexibility: Owning a limited liability company has the advantage of choosing how you wish to be taxed. Limited liability company does not pay corporate taxes on earned profits. Profits pass to the members who pay personal income taxes on salary.
- Profit distribution: Whatever profits or losses your business makes, they can be distributed amongst members in any way you choose. And it doesn’t have to be proportional as it has to be in a corporation. Just make sure you draft an operating agreement in which you specify how much each member gets.
- Raising capital: LLC does not have stocks, so to obtain capital, you have to go to the bank and ask for a loan. Other options of raising capital can be more expensive and time-consuming. Even investors have a hard time investing money in the company because this structure lacks a strict corporate structure.
- High renewal fees: LLCs have to renew their license every year. Renewing LLC is typically more expensive than in other business structures.
When to use:
A limited liability company is perfect for small business owners who don’t want to deal with the complex corporate structure and also benefit from tax savings. If you don’t want to put your personal assets on the line, this is a good option for you.
A corporation defines itself as an entity that is completely separate from its owners and has its own legal rights. That means a corporation can sue, be sued, own or sell property, and so on. A corporation differentiates between various types of corporations. Let’s take a look at some of them a little closer:
- S-corp: Designed especially for small businesses to avoid double taxation. Owners have limited liability protection. It allows profits and some of the losses to pass through directly to the owner’s personal income without ever being taxed.
- C-corp: This one is owned by shareholders and are taxed as separate entities. It allows an unlimited number of investors. C-corp pays income tax on their profits, and in some cases, profits are taxed twice (when the company makes a profit and when dividends are paid to shareholders on their personal tax returns).
- B-corp: Known as benefit corporations, this type of corporation is structured to make an impact on society. Corporations that have a B corporation status are advocates for making a positive change in the environment, domestic violence, climate change, animal testing, etc.
- Closed corporation: Typically run by a few shareholders without a board of directors and cannot benefit from limited liability protection. They are also often referred to as privately held companies and have a less traditional corporate structure.
- Personal liability protection: It provides its owners with certain protection. That means that if the company gets sued, the owners are not personally responsible for the debts or legal obligations of the company. This is one of the main reasons companies choose this type of structure.
- Easy capital: Corporations sell ownership through publicly-traded stock, which is something other structures don’t have. Selling stock is great when you want to grow the company or raise venture capital.
- Tax benefits: C corporation is subject to double taxation, but other structures have tax benefits. This depends on how they distribute their income.
- Long application process: Forming a corporation takes a lot of time, and you will have to go through extensive paperwork to write down all the details of the company and its ownership.
- Rigid structure: You need to follow many rules and heavy regulations to maintain the status of your corporation. That means you need to follow your bylaws, maintain a board of directors, hold annual meetings and create annual reports.
- Expensive: Corporations are from the start expensive to form and operate. You will need a lot of money to keep the company running and paying taxes and fees.
When to use:
Running a corporation isn’t for the weak. Usually, people start with the simplest business structure and work their way up. That way, you learn how to properly run a successful business. Nevertheless, corporations can prove to be a good choice for medium to high-risk businesses that need to raise money, go public, or eventually be sold.
By helping others, they are rewarded by not paying taxes. They focus more on helping rather than making a profit. They are organized to do charity, education, religious or scientific work. A non-profit still needs to file with the IRS to get a tax exemption. Non-profit organizations need to follow special rules about what they are going to do with the money they earn. It is important to say that non-profit organizations can’t distribute profits to members or political campaigns.
- Tax exemption: As you gain the status of a non-profit organization, you don’t have to pay taxes. This can help your organization use the earned money to do more good for society.
- Getting the money: Non-profit organizations are eligible to get grants from the government, private sectors, and other interested individuals.
- Being separate from the organization: If the organization finds itself in any kind of legal trouble, the founders won’t get affected. Since the founders are kept apart from the business structure, that makes them completely risk-free.
- Starting resources: Even if the business is not focused on making a profit, it will still need a lot of money to start the business. And also a lot of time.
- No profit: This organization is meant to make zero profits. None of the founders or shareholders can receive a profit from it, and it can be difficult to generate interest from the investors.
- Hard to fund: This is one of the most burning problems for non-profit organizations. If you can’t convince investors to become interested in what you do, you don’t get the money to keep the business going.
When to use:
Becoming a non-profit organization is not easy. Even the costs of keeping it standing are high if you don’t have anyone to support you. Still, it’s a great jumping point if you want to be in the business. If you know you want to help the society, make a difference in this world or make any kind of other greater good, a non-profit organization can give you a lot of advantages. It’s different from running a standard business where you collect a paycheck each month. With this structure, you can invest in yourself.
Factors to Consider When Choosing A Business Structure
We have already determined that choosing your business structure is an important decision you shouldn’t take lightly. Your business structure has a direct impact on the way your business operates. You should consider as many different factors as you can before picking your structure.
This chapter will go over the most important factors you should consider when registering your company. Make sure you all your answers before filing the papers. Let’s dive right into the things you should consider before starting your business.
How willing are you to share the control over your business? If you’re determined to remain the only one making executive decisions, then we suggest you go with a sole proprietorship. But is that really the best option if you’re starting a business with many employees and a complex organizational structure? Probably not.
We explained how much control each business structure comes with. We suggest you reread everything before making your final decisions. But remember, the amount of control you want to have over your business does depend on the business structure you pick.
This is a big factor that many people take very seriously. Some business structures, like a sole proprietorship, make you (the owner) personally responsible for the assets of your business. This means that if your business goes under, you will be personally liable to pay off the debts of your business.
You can go with any of the business structures that don’t make you personally liable. We mentioned all of them in the previous chapter. But, in all cases, business structures where you’re not personally liable are more complex and come with more paperwork and higher costs of starting. It’s up to you to decide which of these are more important for you and your business.
Will you be raising venture capital for your business? If you will, you need a business structure that allows you to do that. Your investors want to have a say in your business. That means they expect you to have a structure that allows for more decision-makers in the business. A sole proprietorship won’t be able to raise capital.
Make sure you set the right foundations for investors to join your business. The easiest way to do is by picking the right business structure that allows you to bring in venture capital and outside investors.
The more complex your business, the more complex the business structure will be. That’s almost always the case. There are exceptions where we have big businesses operated as sole proprietorships. But these really are exceptions, and we don’t recommend you do the same.
We’re mostly referring to the number of employees and resources you need to operate your business with complexity. The resources can be technical capabilities or the materials you need to produce your products or services. Keep in mind that complex businesses have more rules and laws to follow to comply with the legislation.
Continuity of Existence
There’s a simple question you need to ask yourself – do you want to leave your business for your kids when you retire? You need to keep this in mind as you’re registering the business. Not all business structures can be transferred to other people.
We understand you might not have the answer to this question right now. But it’s better to think about that than to get caught unprepared in a couple of decades.
The type of business structure you select determines your liability and the taxes your business has to pay. As a business owner, you must meet federal, state, and local tax obligations.
Liability and taxes are connected when it comes to business structures. If you register a sole proprietorship, you’re personally responsible for all your business’s losses and liabilities. It also means you’re taxed at the personal level, where other entities, like an LLC, are taxed on a corporate level.
You will have to pay to get your business registered. Some business structures require you to register with your state. This usually comes with different costs like filing fees, franchise tax, attorney fees, and similar. Each of these spans from tens of dollars to a few hundred dollars, and the total costs can add up.
A sole proprietorship doesn’t have to formally register with the state to structure the business. But you will have to pay for permits and business licenses, no matter which structure you choose. As you see, starting a business isn’t always cheap. You have to consider this when starting your company.
As you see, there’s a lot you need to think about before you start your business. We understand it might be hard to go through all of these factors when all you want to do is start. But picking your business structure is one of the most important decisions you’ll make, and it makes sense to spend some time thinking about the factors that determine how you operate your business.
There you have. We just shared everything you need to know about different business structures to help you make the right decision for your business. There’s a lot you need to consider when picking a business structure.
We suggest you come back to this article every time you feel lost or don’t know what to do with your business structure. Don’t forget to use our recommended LLC formation services if you want to simplify the process of registering your business.