Understanding the types of business structures
Know the five most common business structures, and pick the ideal one for you. Presented by Chase for Business.
Perhaps the most important decision you’ll make when starting your own business is how to structure it, since the path you choose will shape and influence several factors going forward. These factors include banking and finance, such as opening an LLC business account or a sole proprietorship business account. They also include how your business is taxed, your personal liability in the event of lawsuits or bankruptcy, the flexibility you (and any potential partners) have in shaping its direction and your ability to attract potential investors.
Explore five of the most common types of business structures for small businesses, along with some of their advantages and disadvantages.
Sole proprietorship
The most common type of business structure is a sole proprietorship. In fact, 86.4% of non-employer businesses (those with no employees other than owner) are sole proprietorships. This has to do with the ease with which it can be set up, the way taxes are structured or the amount of control the business owner has over it.
Sole proprietorships are just like they sound: One person owns and runs the business. This is ideal for solo entrepreneurs, as well as for low-risk home-based businesses or retail. In most states, there’s no need to register a sole proprietorship. However, depending on where you live and the type of business you run, you may need a business license, local permits, or a DBA (“Doing Business As”).
The high amount of overlap between your personal and business finances makes it easy to launch and manage taxes for a sole proprietorship. However, this lack of separation also puts your personal assets at risk. If a customer, employee or another third party successfully sues your business, they can take your personal assets.
Learn more on how to keep your business and personal finances separate.
Sole proprietorship advantages
- Control: no need to consult with partners, directors or shareholders in business decisions
- Ease of startup/setup: few or no forms to complete or fees to pay
- Low cost: nominal license fees depending on location
- Taxes: expenses and income included on your personal income tax return
Sole proprietorship disadvantages
- Liability: potential personal liability for the debts and obligations of the business; potential for personal assets — home, car, etc. — to be used to settle these issues
- Loans and credit: difficult to establish business credit without a registered business entity; banks and other financing sources can be reluctant to loan to sole proprietorships
Limited liability partnership
With a limited liability partnership, two or more parties share ownership of a single business. They contribute to the business either equally or as agreed upon, collectively providing money, property, labor and skill while sharing profits (and losses). And like a sole proprietorship, a partnership can be a simple and inexpensive structure for multiple owners to form.
Two of the most common types of partnerships are limited partnerships (LPs) and limited liability partnerships (LLPs).
One partner in a limited partnership, usually a general partner, has unlimited liability, while all other partners have limited liability. The limited partners, usually investors, have restricted control or input into the company.
On the other hand, LLPs can protect each partner from personal liability for the partnership’s debts, which can help them to avoid responsibility for the actions of other partners.
Limited liability partnership advantages
- Ease of startup/setup: few documents to file with the federal government, though business licenses or other regulatory credentials might be required
- Taxes: LLC itself doesn’t pay federal income tax; profits and losses pass through to partners’ personal income tax
- Shared finances: reduces individual financial burden of starting a company
- Combined knowledge: allows one partner to provide skills or expertise in areas where other partners might be lacking
- Growth: banks more inclined to loan or invest when there’s more than one owner
- Filings: no filing of annual reports, meeting minutes, bylaws, etc.
Limited liability partnership disadvantages
- Liability: partners personally liable for their own obligations and behavior; may also share liability for another partner’s negligent actions or misconduct depending on state laws and circumstances
- Less independence: shared decisions about direction, growth and strategy; shared profits
- Volatility: disputes can potentially dissolve the business
C corporation
A C corp or corporation is a legal entity that, unlike sole proprietorships or partnerships, is considered separate from its owners. It is legally owned instead by its shareholders. The corporation itself — not the shareholders — is legally liable for the actions and debts the business incurs. This limited liability is its biggest benefit. If someone successfully sues the corporation, they can generally seize only business assets to cover the judgment. In many cases, they are unable to come after shareholders’ personal assets.
C corps are more complex than other business structures, with equally complex administrative and financial requirements around regulations, record-keeping, tax obligations and fees. C corps are generally recommended for established, larger companies with multiple employees or for medium- or high-risk businesses that may be trying to raise funds or plan to eventually go public. However, small business entrepreneurs who need more legal protections might consider incorporation.
C corp advantages
- Liability: owners are generally not responsible for a corporation’s debts; personal assets are most likely protected
- Continuity: ownership based on the percentage of stock held; can run without disruption should a shareholder leave or sell shares
- Growth: ability to raise funds by selling company stock and offering shares as employee benefits; easier to locate investors
- Taxes: can deduct retirement plans, health insurance premiums, life insurance and other employee-related expenses
C corp disadvantages
- High cost: more expensive to create C corp than sole proprietorships and partnerships
- "Double taxation": taxed first on the corporate tax return and then on shareholder dividends
- Filings: mandatory quarterly/annual filing of reports, notes from shareholder meetings, meeting minutes and bylaws
S corporation
An S corp allows stock dividends to pass through directly to shareholders’ personal incomes without being subject to corporate taxes, which means there’s only one level of federal tax to pay, rather than two.
Like a C corp, an S corp generally provides liability protection. If the company is sued, usually only corporate assets are liable for seizure. The personal assets of the owners and shareholders remain protected — except in certain circumstances (such as fraud or personal guarantees).
However, the IRS has placed limitations on what defines an S corp. It cannot have more than 100 shareholders, and all its shareholders must be U.S. citizens or resident aliens. Shareholders may not be partnerships, corporations or non-resident aliens. Some states tax S corps on profits above a specified limit, while others don’t recognize the S corp election at all and treat S corp businesses as a C corp.
S corporation advantages
- Liability: shareholder’s personal assets are more likely protected from business debts
- Continuity: business can usually continue even if an owner leaves or sells their shares
- Taxes: pass-through taxation can help avoid double taxation, and there are possible savings on self-employment tax
- Growth: usually easier to transfer ownership than a partnership, and there’s credibility with investors and lenders
S corporation disadvantages
- High cost: can be more expensive to create than sole proprietorship or partnership
- Requirements: generally limited to a maximum of 100 stockholders, all U.S. citizens or resident aliens; only one class of stock is allowed, which could hamper investment
- Filings: mandatory quarterly/annual filing of reports, notes from shareholder meetings, meeting minutes and bylaws
Limited liability company
A limited liability company (LLC) or limited liability corporation is a hybrid type of legal structure that takes advantage of both the corporation and partnership business structures, combining the limited liability features of a corporation and the tax benefits and flexibility of a partnership. This makes LLCs popular among small business owners, including freelancers, since personal assets — including vehicles, houses and savings accounts — won’t be at risk if your LLC faces bankruptcy or lawsuits.
From opening a new LLC online to getting a loan to opening an LLC business account, LLCs are relatively easy to set up. LLC owners are called “members,” and depending on the state you’re doing business in, members can be a single individual (one owner), two or more individuals, corporations or even other LLCs. In addition, profits and losses pass through to your personal income without facing corporate taxes. Note that members of an LLC are generally considered “self-employed” and may need to pay self-employment tax and contribute toward Medicare and Social Security, though this can vary depending on how the LLC is taxed. There are many resources available to help you learn how to open an LLC business account.
Limited liability company advantages
- Ease of startup/setup: generally easy to establish, with fewer corporate formalities compared with an S corp or C corp
- Liability: members are usually not held responsible for a corporation’s debts; personal assets are typically protected
- Taxes: company’s income and expenses generally pass through to personal tax returns of members, where they pay income tax on the profits and may also claim the self-employed tax credit, depending on how the LLC is taxed
- Flexibility: unlimited number of LLC memberships; members are usually able to fully participate in company operations and decide how to divide profits
Limited liability company disadvantages
- High cost: can be more expensive to form than sole proprietorships and partnerships, in addition to state-required fees and licenses
- Limited lifespan: some states mandate LLC dissolution after set period; if an owner joins or leaves the LLC, it may need to be dissolved or reformed
With a better understanding of common business structures and their respective advantages and disadvantages, you can determine which type works best for your business and craft a business plan. Want more insight? Speak with a Chase business banker to find out how to structure your business for growth and success.
