Efficiency cannot exist without structure.
Without structure, businesses would struggle to reach that well-oiled machine status every company strives to obtain.
In business, this structure comes from ownership style. Because no business is exactly the same, there are different types of business ownership, all with different traits that make them suited for some companies and wrong for others.
What are the types of business ownership?
- Sole proprietorship
- Limited liability company
Choosing a business ownership style, also known as a business structure, is a necessary step when starting a small business or when reworking your current business plan.
Common types of business ownership
Let’s take a look at the types of business ownership, along with some pros and cons, to help you figure out which one best fits your ideal structure.
1. Sole proprietorship
A sole proprietorship occurs when someone does business activities but doesn’t register as another kind of business. There is no separate business entity, meaning there is no distinction between the business owner’s personal and professional assets and liabilities.
Sole proprietorships are simple, easy to start, and one of the most common types of business ownership. They are a good option for someone starting a low-risk business on a trial basis. Also, no additional taxation!
However, because there is no formal separation, the business owner will become personally liable for any obligation the business might have.
Similar to sole proprietorships, a partnership is the simplest type of business ownership when two or more people are involved. There are two kinds: limited partnerships and limited liability partnerships.
This term liability is being thrown around quite a bit, so let’s define the types of liabilities we will be looking at when discussing business ownership:
|Liability: being responsible for something by law|
|Limited liability: a person’s liability is limited to a fixed sum, which usually reflects their investment in the business|
|Unlimited liability: there is no limit to the liability and the owners take full responsibility for the companies’ debts|
A limited partnership has one partner with unlimited liability while everyone else involved has limited liability. With limited liability, comes limited control. Since being a partner with limited liability is less of a risk, they get less say in decision-making processes.
A limited liability partnership has only one class of owners, meaning there is no partner with the risk, and power, of unlimited liability. A limited liability partnership shares the liability among the owners, protecting them from the mistakes of their partners.
Neither of these partnership types pays additional taxes.
3. Limited liability company
Not to be confused with a limited liability partnership, a limited liability company (LLC) separates the owner’s personal and professional assets. Meaning if your business gets hit with a lawsuit or goes bankrupt, your house, car, and personal piggy bank are safe.
Similar to sole proprietorships and partnerships, LLCs do not pay additional federal income taxes or those associated with being a corporation. However, depending on their location, they might be subject to other state taxes. Also, LLCs fall under the category of self-employment, so those taxes fall on them as well.
An LLC is a good choice for a business owner willing to take a little bit of a bigger risk or one looking to protect their personal assets.
There are actually a few separate types of corporations, and each one has something that makes it a little different.
A C corporation, or just a regular corporation, is its own entity kept separate from its owners. This means they offer the most protection in terms of personal liability.
Corporations have an advantage when it comes to funding: stock. A stock is a partial share in a company, so when people buy stock, they are essentially buying ownership and decision-making responsibilities.
However, starting a corporation costs more than any other business structure. Not only are they legally required to do keep more records and release more reports, but they also pay income tax. In some cases, there is even double taxation - once on profits, and then again on the dividends distributed to stockholders.
With so many different stakeholders contributing to the same business, corporations become solid. If someone leaves, the business remains relatively unaffected.
A corporation is a good structure for a business owner looking for a little more risk, good funding options, and the prospect of eventually “going public,” which means the company will eventually sell stock to the public.
An S corporation, or S corp, is a type of corporation that is meant to avoid the double taxation that hits normal C corporations.
To become an S corp and avoid that taxation, you file a special election. Once the business is officially an S corp, it is no longer taxed on profits. Instead, all profits, and losses, are passed on to the stockholders.
However, this is not possible everywhere. There are certain states that tax above a certain limit and some just tax them like a C corp.
Becoming an S corp isn’t possible for everyone. If you have more than 100 stakeholders and any stakeholders that aren’t citizens of the United States, you are out of luck. You can find other S corp criteria here.
Benefit corporations, or B corps, have missions similar to non-profit organizations, but they are, in fact, a for-profit corporation. Their stakeholders have the goal of providing a public benefit, but they also want to see a profit.
Certain state governments also want to see that public benefit; some require B corps to submit benefit reports that prove they are contributing to the good of the public.
Even though they might have different purposes, B corps are not taxed differently form C corps.
A close corporation resembles the structure of a B corp. A lot of the rules associated with smaller companies also apply to close corporations.
With other types of corporations, anyone can own stock. If there is stock available and they have the money, it’s theirs. This is where close corporations differ: the stocks are owned by people that are closely related to the business.
Stockholders in close corporations benefit from liability protection while also being free of reporting requirements and pressure from shareholders that don’t know much about the business.
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Nonprofit corporations work in charity, education, religion, literature, or science. Because they exist to serve the common good, nonprofit corporations do not pay any state or federal taxes on their income.
To obtain this tax-exempt status, nonprofit corporations must register with their state, follow similar rules to standard C corporations, and all money must go back into the organization. In other words, profits can’t be distributed to the members of the organization. This does not mean nonprofits do not pay their employees.
A cooperative is a private business owned and operated by the same people that use its products and or services. The purpose of a cooperative is to fulfill the needs of the people running it. The profits are distributed among the people working within the cooperative, also known as user-owners.
There is typically an elected board that runs the cooperative, and members can buy shares to be apart of decision-making processes.
Choosing the right business ownership style is an important and scary step for any burgeoning entrepreneur. There are a lot of solid options, all with compelling benefits and worrisome hindrances. Educate yourself on the myriad types of business ownership before making your decision.
Think you have what it takes to be your own boss? Learn how to start a small business to make that dream a reality.