12 types of businesses and factors to consider when choosing one
12 types of businesses and factors to consider when choosing one
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When you started your business, you probably liked checklist items that allowed you to express your creativity, such as: E.g. perfecting your sales pitch or creating your company website. Other steps may be less obvious and less intrusive, but they are just as important, sometimes even more important.
In fact, one of these background tasks is so important that it is the first step you should take after starting the installation. This means you need to decide what type of workflow you want to use to start your business.
This decision affects almost everything we do. It can be easy to think of your options as purely formal, but it is important to research your options thoroughly to ensure the success of your venture. In this article we will look at:
- Why is your business type important?
- 12 types of corporate structures
- Here’s how to decide what type of business structure is right for you
The four most common types of business structures are sole proprietorships, partnerships, corporations and LLCs. However, there are subcategories and other types of businesses within these classifications that need to be considered.
The type of business is determined by the organizational structure or business strategy. Each type of business has its own advantages and disadvantages, especially when it comes to accounting, taxation and liability. This section provides a detailed overview of each of these business types:
01. Sole proprietorships
The sole proprietorship is the simplest and cheapest form of business as it does not require many legal formalities. It is an unincorporated, unincorporated company with a single owner who receives all profits but is also responsible for all liabilities and losses.
An owner is a passerby. This means that entrepreneurs can claim a profit on their own tax return. This makes accounting and tax reporting difficult and entrepreneurs only have to pay one type of tax.
On the other hand, sole proprietorship can be a risky option as the owner legally has full responsibility for the company's activities. Therefore, if your personal property is in legal or financial trouble, your personal assets (such as your home and personal savings) may be at risk.
However, a sole proprietorship would be a safe bet if your business does not involve significant start-up or operating costs and you do not plan to involve others in the business. This business structure is particularly suitable for freelancers, online shop owners, personal trainers and consultants.
If you're looking to start a side hustle or aren't sure if your business will grow into a full-time gig, consider starting as a sole proprietor. You can always change your business structure later as your business thrives. Pierre Omidyar, for example, founded eBay as a sole proprietorship in 1995 and incorporated it seven months later.
02. Limited-liability companies (LLCs)
An LLC is a hybrid of a corporation and a partnership and is one of the most flexible options for organizing a business. This type of business combines the liability protection of a corporation with the benefits of transfer tax and the flexibility of a sole proprietor. The owners of a corporation are generally not liable for the debts and liabilities of the corporation, but unlike corporations, LLCs are not subject to deferred taxation.
LLCs do not issue stock to employees or other foreign investors. Instead, it offers membership to people interested in property ownership. Members may manage the day-to-day operations of the LLC or serve as a corporate board of directors, overseeing the activities of the company's directors and officers who are not members. Because there are more opportunities to mix member and employee roles, employees of LLCs tend to bear greater personal liability than those in corporations.
The types of businesses that use the LLC structure range from sole proprietorships to large corporations. Forbes, Deloitte and Kind are some prominent examples of LLCs.
Read more: How to start an LLC
As the name suggests, a partnership is an agreement between two or more people to jointly form a business and oversee its operations. Forming a partnership is an easy way to share the profits and liabilities of a business.
Like sole proprietorships, partnerships are easy and inexpensive to form because you don't have to form a separate legal entity. In addition, a partnership, like a sole proprietorship, is a pass-through entity. Profits are usually distributed directly to the individual partners and are taxable as personal income.
Partnerships are not a one-size-fits-all solution. There are three types, each with different features, advantages and disadvantages. Regardless of the form of your business, it is a good idea to draft a partnership agreement that clearly defines roles, responsibilities, and profit-sharing formula.
03. General partnership (GP)
If you plan to run your business as a true partnership, sharing responsibilities, profits, and risks equally with your partners, a general partnership is right for you. Each partner has an equal say in legal decisions and day-to-day operations, and all members share profits and losses equally.
This equation extends to liability. All partners are equally responsible for debts and legal issues, even if only one partner is the direct cause. If a partner leaves, the entire firm is dissolved.
Professional service companies with two or more founders, such as architectural firms or advertising agencies, are often suitable for listed companies. Businesses that need start-up capital, such as restaurants or art galleries, also set up GPs.
Limited partnerships include general partners, who run the business and assume all liabilities, and limited partners (commonly called "silent partners"), who contribute capital but do not participate in the operations of their company. This can happen any day. Silent partners receive a pro rata share of profits and their liability is limited to their initial investment in the company.
LPs are easy to set up and take down, making them particularly suitable for short-term projects that require large investments. For example, film productions are often managed as LPs in which the studio is a general partner and the investor is a silent partner. LP business structures can also be useful for real estate projects, private equity firms and small businesses that require large investments.
05. Limited liability partnership (LLP)
In an LLP, each partner has limited liability for the impacts and activities of the business, even though each partner takes an active role in running the business. Each partner benefits from a simple profit-sharing plan while being protected from debt and liability to the entire company.
The rules for forming an LLP vary from state to state. In some jurisdictions, only certain professions that require licensing, such as doctors, accountants, and financial advisors, can form an LLP. An LLP allows professionals to share overheads and profits without being exposed to malpractice claims against other members of the group.
Corporations
When you form a corporation, your business exists separately from you. It is an independent legal entity with its own management, taxes, and liabilities. The structure significantly reduces potential risk for owners and investors because no one can be held personally liable for the company's impacts, activities, or liabilities.
The downside to this protection is its complexity. Businesses are subject to more record-keeping requirements and regulations than other types of businesses. Businesses of all sizes and types face significant administrative burdens.
06. C corporation (C corp)
A C corporation is the type of business you most likely associate with the word “corporation.” It is a legally constituted entity with a board of directors responsible for directing business decisions. C-corps pay corporate tax on profits, meaning the company is taxed as a sole proprietorship and its individual employees and shareholders are taxed on their personal income.
C-Corps are generally more complex to form and manage than partnerships or sole proprietorships, but responsibility and ownership are more easily transferred. The administrative burden can be favorable for companies that have the potential to grow quickly and expand globally immediately.
07. S corporation (S corp)
An S corporation is a hybrid corporate form. An S Corp is a separate legal entity with all the structure and governance of a C Corp. However, like sole proprietorships and partnerships, S Corps impose a pass-through tax, which allows shareholders to claim business profits on their personal income taxes. As a result, S corporations avoid much of the double taxation of C corporations.
A company must meet certain criteria to qualify as an S Corp. Some of them:
- In most states, an S Corp is limited to 100 shareholders. This makes it more difficult to raise capital through stock sales than with a C Corp.
- Shareholders of an S Corp must be U.S. residents.
- An S Corp typically has only one class of stock and all shareholders generally have equal voting and dividend rights. In contrast, C corporations can issue different classes of stock that favor certain shareholders' votes and provide different dividend benefits.
08. Close corporation (CC)
Because they are not publicly traded, closely held companies (typically referred to as "private companies" or "family businesses") are subject to looser governance and reporting rules than other companies and offer shareholders flexibility and control similar to partnerships. The number of shareholders is limited and usually consists of family members, employees and other people directly connected to the company. This structure allows shareholders greater control and flexibility in running the company, similar to a partnership.
While this format may be associated with small businesses, closely held companies are also ideal for larger companies that require a corporate structure while still retaining family or individual ownership. The supermarket chain Publix and the manufacturing company Kohler are examples of large private companies.
The nonprofit designation supplements the company's basic business structure and does not affect its federal tax status. Depending on where you live, C Corps, S Corps, CC, and Co-op may qualify for PBC.
PBCs, also known as “Benefit Corporations,” publicly commit to balancing profit-making and acting in the best interests of society and the environment. This corporate structure differs from the Certified B Corp certification, which is a separate designation that companies receive from the nonprofit organization B Lab. Therefore, your company can be a non-profit corporation even if it is not a Certified B Corp. am.
For example, Warby Parker is a C-Corp with a PBC designation and B-Corp certification. This means a listed company that prioritises social and environmental objectives over the interests of shareholders. B Corp status means that B Lab has confirmed that it meets the criteria for social and environmental impact.
10. Nonprofit corporation
Nonprofit organizations are technically considered corporations because they must file their articles of incorporation with the state in which they are registered. But otherwise, nonprofits have little to do with mainstream businesses.
Even compared to B Corp, nonprofits have very different structures and goals. A B corporation can still make profits and pay dividends to shareholders, but a nonprofit has no shareholders and is not required to pay dividends. Instead, the money is reinvested.
To be considered a nonprofit organization, an organization must meet several criteria. However, once nonprofits are incorporated, they are exempt from federal income taxes and can apply for grants and other donations.
Notable nonprofits include the Sierra Club and Habitat for Humanity. Likewise, local cultural institutions, churches and charities are almost always organized as non-profit organizations.
11. Cooperative
Like nonprofits, cooperatives (also called “co-ops”) are technically businesses, but they have unique characteristics that set them apart. A cooperative is owned by its customers, its employees, or both. There are no shareholders or shares. As with S-Corps or partnerships, gains are taxed only as personal income.
Most importantly, no owner has a disproportionate ownership interest. While executives in a traditional company may own more shares than a front-line employee, in a cooperative every member has an equal say. Employee-owners have a strong interest in the company's success and are often motivated by socially conscious business goals.
Another retailer, REI, is one of the best-known examples of a consumer cooperative, where customers pay a one-time membership fee to receive annual dividends. One of the largest employee-owned cooperatives, Cooperative Home Care Associates provides home care services in the New York City area.
12. Joint ventures
If you're teaming up with another company to collaborate on a specific project or task, you can make your strategic partnership official with a joint venture agreement. Formalizing the relationship ensures that your company maintains its independence while benefiting from the resources of other participants. Joint ventures can help you and your partners take action on urgent matters more quickly than you would like.
Planning ahead is crucial to ensure roles and responsibilities are clear. Negotiate your share of the costs and liabilities of the project and formulate a clear exit strategy in advance. Otherwise, if the project stalls or fails, you will find it difficult to complete the project without incurring significant legal costs.
Any type of company can be involved in a joint venture: For example, a C-Corp can partner with a nonprofit organization for a charitable initiative, and an LLC can form a joint venture with a partnership. A C-Corp can do the same thing with a nonprofit organization. For example, at the outbreak of the global pandemic in 2020, diagnostic testing company Renalytix AI formed a joint venture with Mount Sinai Health System's Kantaro Biosciences to develop COVID antibody testing kits.
Why does your business type matter?
Your business type (i.e., “corporate structure” or “business entity”) is the legal guide for forming and running your business. The business structure you choose determines ownership, profit sharing, decision-making, legal requirements and taxes.
In addition to these overarching parameters, company structure is influenced by many aspects of daily life, such as: E.g. the administrative burden, record keeping and tax planning. Banks and investors consider your business structure when deciding whether to grant you a loan or other financing. If your company is in legal or financial trouble, your corporate structure will determine who is responsible.
In other words, the type of business you choose will impact your company's management style at every level. Therefore, it is important that you review this decision carefully and ask your financial advisor, lawyer or accountant to review it carefully. If you are unable to hire someone at the moment, professional associations, local chambers of commerce, mentoring networks and business advisors may also be able to provide you with advice on this matter.
You can transition your business from one type to another if your circumstances change, but the process can be expensive and time-consuming. Therefore, it is best to start your business with the best possible growth and flexibility options.
How to decide which type of business structure is right for you
For the long-term success of your business and to avoid legal or financial problems in the future, it is important to weigh the pros and cons of each type of business. Consider the characteristics and goals of your business and explore the structure that best fits your vision. Some specific ideas include:
Startup costs, complexity and speed
Establishing any type of business requires a different level of investment. For example, forming a corporation or LLC requires paperwork, but most states allow you to file your taxes as a sole proprietorship without registering a business.
Tax implications
The type of business you form has a significant impact on your taxes. Requirements vary at the state and local levels, but general tax categories apply:
- Pass-Through Tax Status: Sole proprietorships, partnerships, S Corps, LLCs, and cooperatives have pass-through tax status. As already mentioned, this means that entrepreneurs can claim business profits on their own tax return.
- Double taxation: Double taxation occurs when a company's profits are taxed at both the corporate and individual levels. A C Corp is taxed as an independent corporation, and shareholders and employees are taxed on their personal income. Closely held corporations, B-Corps and cooperatives are subject to corporate income tax unless they apply for S-Corp status.
- Tax Exemption: Nonprofit organizations are exempt from taxes, but their employees still have to pay income tax.
For complete, up-to-date information on the tax implications of your business structure, please consult the IRS website.
Liability
Having a problem with the problem is an important consideration when deciding what type of business to start. If you are entering a volatile market, expect thin margins, require a significant financial investment, or provide professional services related to medical malpractice claims, protecting your personal assets may be a good choice.
Fundraising
Some types of companies allow third parties or institutions to invest in your company as partners or shareholders, while others do not. If you already have additional stakeholders or plan to add more in the future, you need a structured fundraising website to raise money and a business structure that can accommodate them.
Additionally, if you seek financing from a bank or business lender, you may need to set up a formal business structure instead of a sole proprietorship or partnership. Likewise, a nonprofit qualification is often required for mission-driven organizations seeking grants and large donations.
Purpose vs. profit
If your company or organization has a mission rather than revenue, you may decide to build a structure that formalizes these priorities. The truth is, B Corps and co-ops must balance profit generation with social and environmental goals. Reasonable businesses may qualify for targeted investment opportunities, grants and government programs.
Local and state laws
Business structures are determined in part by federal tax laws, but state and local regulations also play a role in determining how a company operates and which legal entities it will use. For example, some states require formal registration of partnerships, but not all states recognize closed corporations. Research your options carefully to understand the legal, liability and tax implications of the structure you are setting up.
Business types and entities FAQ
What are the most popular business types?
- Sole proprietorship: Simple and easy to set up.
- Partnership: Ownership of two or more people.
- Limited Liability Company (LLC): Combines liability protection and tax benefits.
- Business: Ideal for larger companies that want to invest.
- Franchise: a pre-established brand and business model.
What is the easiest business type to start?
Sole proprietorship is the easiest type of business to set up. Very little paperwork is required, usually just a local business license. You are in complete control and your profits are taxed once based on your personal income level. This simplicity makes it ideal for individual entrepreneurs to get started.
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