What You Need to Know About Business StructuresMehvish Abdani
What You Need to Know About Business Structures
Starting a business is one of the most promising avenues for taking control of your career and achieving financial success. In fact, 99.9% of US businesses are small, highlighting the entrepreneurial spirit’s key role in driving the economy.
Entrepreneurs who aim to join the fold and launch their businesses must find the right structure before mapping out their business plans. Choosing the right business structure aligned with your goals boosts long-term sustainability and profit. Taking the time to do your research before launch can determine what makes you a part of the 80% of new businesses that survive their first two years.
Read on for the common business structures that are most promising to individuals across industries.
A sole proprietorship is considered the “easiest” among all the business structures to set up because it doesn’t require a lot of paperwork and is considerably more affordable to set up in terms of costs. This structure sees a singular individual who owns and manages the business, hence its name.
You’ll usually see that this structure is chosen by entrepreneurs who don’t plan to take on any employees. That said, it is legally acceptable for sole proprietorships to employ workers. This will require further filing for payroll taxes and employee regulations.
In terms of legal standing, the business is considered the same entity as its owner. This means that all liability falls onto the proprietor. Although this does give the owner more direct control and ease of starting, it also means that any debts and legal obligations will be directed to the individual. Pass-through taxation means the proprietor reports income and losses on their personal tax returns.
According to the US Census Bureau, there are more than 21 million registered sole proprietorships in the country. Those looking to register their own business with this structure may benefit from the use of SME budgeting apps like Mint, YNAB, and Pocket Gaurd, as they will take on the full legal burden of the business themselves.
Limited Liability Company (LLC)
A limited liability company (LLC) can have one or more people serving as members or owners. In this structure, limited liability prevents owners from personal responsibility for business debts. This is because it is considered a separate entity from its owner.
Different states have their own rules in terms of LLC taxation, but owners can generally expect more freedom in terms of choosing how to be taxed. An LLC is initially classified by the IRS as a sole proprietorship, though multimember LLCs will be considered partnerships. As such, they will initially receive pass-through taxation. LLCs can also elect to be taxed as corporations.
A guide on how to start an LLC notes that this type of business structure also has the freedom to curate their operating agreement, minimizing risk and any profit dispute between members in the future. This can also establish how income is divided among members. This business structure protects the owner(s) personal assets regardless of their tax status.
A partnership involves more than one individual serving as the owner of the business. This will usually require an official partnership agreement to be made for legal processing. In that, financial arrangements and duties should be thoroughly broken down.
The exact nature of the entity will depend on what type of partnership is formed. The most common is the general partnership (GP), in which all partners have equal decision-making power, contributions, and shares. Every partner will have unlimited liability for any debts or legal obligations incurred by the company.
Another is the limited partnership (LP), which has room for some partners that don’t contribute as much in terms of responsibility and liability. Instead, they primarily earn their role by investing in the business.
The limited liability partnership (LLP) is similar to a GP but offers limited liability, unlike an LLC. The biggest difference between an LLP and an LLC is how it is taxed, especially as partners and members have different legal responsibilities.
Regardless of the type of partnership built, it’s wise to make use of an outsourced Chief Financial Officer (CFO) for business operations. This provides good scalability and compliance at a more accessible cost than a full-time expert. By outsourcing, you can minimize disputes and profit anomalies between partners while executing a solid financial strategy. In the long run, it also helps with a partnership’s financial risk and cost management.
Corporations are commonly the business structure used by large companies. Alternatively, they also often see usage in high-risk businesses that require a lot of seed funding. The US Small Business Administration data shows that corporations often plan to “go public” and fund via stock sales.
There are different types of corporations built for profit. An S corporation will have every shareholder taxed but continue to operate should they leave. B corporations are, as noted by the administration, driven by mission and profit. C corporations are the most common type of corporation taxed separately from their owners. While the S corp gets taxed partially through, the C corp will require the corporation to pay taxes based on profit, and owners will still pay personal income tax.
As such, this business structure requires the most financial stringency. While other types also benefit from the guidance and services of a CFO, this is the entity that will truly need one full-time. Cash flow, financial compliance, and future planning will be the biggest factors that make a CFO a crucial pillar in this structure.
A cooperative sees profit distributed equally among members who actively own and operate the business. This means anything the business does is for the benefit of the members. In the context of this business structure, owners are called “member-owners.”
What differentiates this from other structures is that every member is able to provide input on how services or operations are executed. In other entities, certain individuals may have more liability and standing power to enact business decisions. As one can easily decipher from the name, this type of business will truly prioritize operations and management as a group. You will likely see multiple member-owners who make up a board.
This business type needs strict financial governance to optimize resources and align key objectives. This makes the trajectory and sustainability of the business more feasible, especially as the business still needs to profit in order to remain manageable. Expert Tips on Financial Budget Management highlights budget creation, financial analysis, and income forecasting.