Starting a business is exciting, scary and—let’s be honest—very, very confusing.
If you’re like most small business owners, you might not be fluent in “business legalese,” or have an MBA or formal business training.
This can make navigating the process a little tricky; deciding what kind of business structure to form is a frequent trouble spot.
A sole proprietorship, a partnership, an LLC, a C corp (and what about an S corp or a B corp?)—how do you choose which one is right for your business? And, moreover, what do they even entail?
This comprehensive guide gives you an overview of each business structure. There is no single “best choice,” but this guide will help you choose the right structure for your business.
So, let’s dive right in—here are the most common business structures you’ll encounter. I’ll go over who the business structure is right for, how to establish one, and things to keep an eye out for with each.
Sole proprietorship
A sole proprietorship is one of the most common small business structures.
It’s your business and yours alone, meaning you assume full responsibility and therefore are entitled to all the profits—and, it follows, are liable for all the losses.
Who is a sole proprietorship for?
If you are planning on running your small business by yourself, and you’ll be in charge of the various aspects of running your business and producing your products or services, a sole proprietorship may be for you.
For example, a personal trainer who is planning on offering one-on-one coaching for clients would be a great candidate for a sole proprietorship. So too would an artist who creates beautiful one-of-a-kind jewelry to sell on Etsy. Though plenty of other types of businesses can work well as a sole proprietorship, that should give you some idea.
How do you form a sole proprietorship?
A sole proprietorship is also the easiest business to form; no action is required on your part to become a sole proprietor.
So, you’re already selling your unique jewelry on Etsy? Congratulations—you’re a sole proprietor.
However, there will still likely be licensing and regulatory hoops to jump through, depending on your industry. You’ll want to check with your local secretary of state’s office website.
See Also: How and Where to Obtain Business Licenses and Permits
Additionally, if you’re planning on doing business under a name that isn’t your own, you’ll need to file for a DBA, or “doing business as.”
I covered how to get a DBA in this article here, as well as other details on how to register your business name, so check that out before you get started.
What should you be aware of?
A sole proprietorship is fairly straightforward to form, but here are some considerations:
Your taxes will be fairly easy: A sole proprietorship is what’s known as a “pass-through” tax entity, meaning that all the profits and losses pass directly through the business owner and are reported on their taxes. If you’re the only person working for your sole proprietorship, a Schedule C form, a form 1040, and a Schedule SE form are the only additions you’ll need to make.
You can still have employees: Just because you’re a “sole” proprietor doesn’t mean you can’t have employees. If you have employees, your taxes will be a bit more complicated, but not by much; see the IRS sole proprietorship page for more information.
You may have more difficulty raising money: As you cannot sell any stock in your company, you will not be able to increase your company’s worth that way.
You’ll likely have trouble getting a bank loan: Banks are often reluctant to give business loans to sole proprietorships, as they are seen as less credible.
You are assuming full liability: If your business fails and you become overburdened with debt, your personal assets (like your car, house, or similar) are at risk. You are also personally liable for any legal issues that may come up. That means that if someone sues you, they could go after your personal assets.
Further reading:
Sole Proprietorship Basics
How Sole Proprietorships Are Taxed
Partnership
So, let’s go back to that example of the personal trainer, who could start a sole proprietorship business and offer client coaching.
But, maybe she wants to pair up with a nutritionist, and the two of them plan on building a fitness empire together. Both entrepreneurs share ownership, and have shared input and participation in the company.
Now you no longer have a sole proprietorship—you have a partnership.
Still a fairly simple business structure, a partnership involves two or more individuals sharing ownership of their new business. They’ll both contribute to the business in some way, and share in both profits and losses.
Who is a partnership for?
Think of a partnership as a slightly expanded version of a sole proprietorship. It’s similarly easy to form, and best for two or more people who want to formally agree to be business partners, and start a business together.
So, that personal trainer and nutritionist pairing? A perfect partnership, as they both bring something to the table and are equal participants in the business. So too would be a pair of entrepreneurs launching an online consulting business, two master brewers starting a local brewery, and so on—you get the idea.
Types of partnerships:
Before we get into how to form a partnership, let’s take a look at the different partnership options. There aren’t many, but the type of partnership you choose will depend upon how long you plan to be partners, and how active a role all involved parties will take in your new business.
General partnership: A general partnership assumes that all parties are equally involved; that is to say, all profits, liabilities, and duties within the company are distributed evenly. If there is an intentionally unequal split in the partnership (for instance, if one partner opts to accept a greater portion of work in exchange for a greater profit share), this must be noted on the official partnership agreement.
Limited partnership: A limited partnership (also known as a partnership with limited liability) is often used for partners who serve an investor role only, and have limited input into the actual running of the company. It’s a significantly more complex structure, but also less frequently used.
Joint venture: If you plan on partnering up for one specific project, a joint venture might for you. Joint ventures function the same as a general partnership, but for a confined span of time, such as the completion of a one-time project.
How do you form a partnership?
Similar to a sole proprietorship, simply doing business together effectively forms your partnership. However, if you plan on doing business under a name other than that of yourself and your partner, you’ll need to file a DBA. You may also need to apply for certain licenses and permits, depending on your business and your state.
What should you be aware of?
Here are a few things to keep in mind before launching your partnership.
A partnership agreement is strongly recommended: While not essential, outlining a partnership agreement (preferably under the supervision of each partner’s attorney) is a good way to make sure you begin your partnership right. This can help you clearly lay out who is responsible for what, and what will happen if you decide to stop working together.
Partnerships are also “pass through” tax entities: Like a sole proprietorship, partnerships “pass through” all profits and losses to the partners. See the IRS partnership page for more info on filing your partnership taxes.
Don’t forget about added expenses: Since it’s a good idea to have a lawyer look over your partnership agreement, don’t forget to factor in this added expense.
Make sure you have a partner you can trust: It should go without saying, but as partners are solely responsible for any bad business dealings or debt that they may incur, make sure that you choose a partner that you trust with your business, your credit score, and your reputation. Again, don’t skip the partnership agreement—it will help you avoid problems down the road.
Further reading:
Partnership Basics
Creating a Business Partnership Agreement
How Partnerships Are Taxed
Limited Liability Corporation
Should your business fall on hard times, does the idea of being held personally responsible for all losses sound intimidating?
It’s understandable—plenty of would-be entrepreneurs shudder at the thought of the bank seizing their personal assets should the business go south.
A limited liability corporation (or LLC) is, in some ways, the best of both worlds. It allows for the flexibility of a partnership or sole proprietorship, but, as the name suggests, limits the liability of those involved, similar to a corporation.
Who is a limited liability corporation for?
If the idea of taking on complete personal liability for your business makes you hesitant to start one, you might want to consider a limited liability corporation.
So, if you have substantial assets that you wish to protect and not involve in your business, an LLC might be right for you. On the same note, if you’re in an industry where lawsuits are common, having an LLC as your business structure can potentially protect your personal assets.
How do you form a limited liability corporation?
The process of forming an LLC is slightly more complex than a sole proprietorship or a partnership; you’ll have to choose a compliant business name, file your articles of organization, and create an operating agreement, in addition to any industry specific licenses or permits and a DBA, should you choose to use one.
Check out our articles on forming an LLC at the end of this section for more information.
What should you be aware of?
While there are clearly advantages to forming an LLC, it’s a more complex business structure than a sole proprietorship or a partnership, and you should determine first whether or not an LLC is right for you.
With added protection comes added difficulty: Compared to a sole proprietorship or a partnership, there’s no doubt about it—an LLC is more difficult to form. While this shouldn’t deter you, it’s a good thing to keep in mind.
Tax incentives are a big plus: An LLC is still a “pass through” tax entity. But, with an LLC, you’ll be taxed on your share of the profits only, which are filed on your personal taxes. See the IRS limited liability company page for more info.
You can form an LLC of one: In nearly all states (sorry, Massachusetts) you don’t need multiple people (referred to as “members”) to form an LLC. Depending on your situation, and LLC may be a good alternative to a sole proprietorship.
Further reading:
LLC Business Basics
How to Form a Limited Liability Company (LLC)
A Guide to Crafting Your LLC Operating Agreement
How Limited Liability Companies (LLCs) Are Taxed
Corporation
When most people think of a business structure, a corporation is likely what jumps to mind first.
The shareholders, the more complex legal structure, and more intricate tax requirements are all characteristic of a corporation.
Who is a corporation for?
A corporation is the most complex business structure; so, if you’re just starting out and are working either by yourself or with just a few others (like a partner or a few employees), then a corporation might not be for you.
This business structure is recommended for companies that: are larger and more established, have many employees, intend to sell stock in their company, will be scaling quickly, have many outside investors, or some combination of these traits.
How do you form a corporation?
To form a corporation, you’ll have to register your business name to start. You’ll also need to file your articles of incorporation, as well as get a Federal Tax Identification number (also known as an employer identification number or EIN).
See Also: How to Apply for a Federal Tax ID Number
For more detailed information on how to form a corporation, see our “further reading” at the end of this section.
C corp, S corp, B corp—what’s the deal?
While the most common type of corporation is technically known as a “C corporation,” or “C corp,” there are a few other types of corporate structures you should be aware of.
Here’s a breakdown of the different types:
C corporation: What we typically think of when we refer to corporations. With a C corp, all shareholders combine funds and are then given stock in the newly formed business. A C corp is a completely separate tax entity in the eyes of the IRS, meaning that your business can take tax deductions. It also means that earnings can be taxed twice, both as they stand in relation to your business and on your personal taxes if you take income in the form of dividends. However, good tax planning can often minimize the impact of double taxation.
S corporation: An S corp is similar to a traditional C corporation, with one major difference: Profits and losses can be “passed through” to your personal tax return. To become an S corp, you must first set your business up as a corporation within your state, and then request S corp status. The IRS instructions for Form 2553 (which is what you’ll need to file to become an S corp) can help you determine if you qualify. You can also request S corp status for your LLC, however it’s advisable to speak with an attorney before beginning this process.
B corporation: Does your company have a dedicated social mission, a good cause built into its foundation that you’d like to continue furthering as your company grows? If so, you might want to consider becoming a B corporation, which stands for “benefit corporation.” However, the name is a bit misleading; a B corp isn’t an entirely different structure than a regular C corporation. It’s merely a C corp that has been vetted and approved for B corp status. Some states give tax breaks to B corps, and it’s a great way to stand behind a cause.
What should you be aware of?
While there are advantages to forming a corporation, it’s certainly not for everyone, as corporations are the most difficult types of businesses to form. Here are some things to keep in mind:
You’ll have the most limited liability possible: A corporation is an entity unto itself; the concerns that a sole proprietor or partnership face if the business goes bad aren’t present for a corporation. Your personal assets are fully protected if you start a corporation.
Corporations have more potential to raise capital: Corporations can sell stock, which increases their ability to get investors.
Separate taxation: Corporate taxes are filed separately from personal taxes, meaning that your business will be eligible for tax breaks. See the IRS corporation page for more info.
Corporations are more difficult to set up: The biggest potential downside to starting a corporation is the fact that it’s the most complicated business structure, and therefore takes the most work to establish.
Double taxation can be a factor: Depending on the size of your business, this may not be an issue. However, you will probably want to work with a business accountant on this one—which may be an added expense and hassle for a very small business.
Further reading:
How to Form a Corporation
How Corporations Are Taxed
S Corporation Business Facts and Options
What Is a Benefit Corporation?
Nonprofit
On the opposite end of the business structure spectrum, you’ll find nonprofits.
They differ greatly from the previous business structures, for one obvious reason: they’re a “not for profit” business structure, meaning they do not exist to generate revenue for shareholders, but rather funnel business revenue into a social mission, cause, or purpose.
Who is a nonprofit for?
A nonprofit business is great for those whose businesses mission is charitable, educational, scientific, religious, literary—essentially, businesses that qualify for tax-exempt status.
This can include organizations that provide shelters for the homeless, conservation groups, performing arts centers and museums, various education centers, and more.
How do you form a nonprofit?
Forming a nonprofit is similar to forming a corporation; you’ll need to file your articles of incorporation, as well as file for tax-exempt status with both your state and federal government.
What’s the difference between a nonprofit and a cooperative?
Similar to a nonprofit, a cooperative is a business with a social mission that doesn’t divide income between shareholders, but rather toward a cause or purpose. However, while some states view nonprofits and cooperatives as the same, a cooperative differs in the sense that it is owned by the members, referred to as “user-owners.”
If you plan on organizing your business so that it is democratically owned, it might be a good idea to look into the cooperative business structure.
What should you be aware of?
Starting a nonprofit can be deeply rewarding, but as they’re similar in structure to a corporation, they’re not a walk in the park to form.
You’ll need to treat your setup like a corporation: Filing your articles of incorporation, creating bylaws, appointing board members and holding board meetings—while your mission may be to make the world a better place, it’s not a quick and easy process and there’s a lot of legwork (and paperwork) involved.
Fundraising will be your main priority: Nonprofits generally rely on fundraising and grants to keep a flow of income into their business.
Further reading:
How to Start a Nonprofit
How to Start a New Business as a Nonprofit Corporation
Running Your Nonprofit Corporation