When you launch a new business, you’re immediately confronted with a long list of decisions, including important choices about marketing, branding, sales, logistics, funding, and more. Perhaps the most foundational choice of all is your decision about which business structure to choose. Whichever structure you choose, it will have lasting ramifications for virtually every aspect of your business startup.
There are four basic options to be aware of: Sole Proprietorships, Partnerships, Limited Liability Companies, and Corporations. In this guide, we’ll evaluate the nature of each, including major pros and cons.
Sole Proprietorships
A Sole Proprietorship is a business in which one person (the business owner or entrepreneur) makes all decisions about day-to-day management and operations. This person also claims all business revenues, and is liable for all business losses or debts.
The Sole Proprietorship is really the default option. When you initially start to generate income on the basis of any type of self-employed activity, the government automatically classifies you as a Sole Proprietor.
The Pros and Cons of a Sole Proprietorship
There are a number of advantages to this business structure, but also some significant drawbacks. It’s important to be mindful of both.
The biggest perk is the ease of forming and maintaining Sole Proprietor status. From a regulatory standpoint, Sole Proprietorships have little in the way of overhead. Sole Proprietors can maintain total autonomy and control of their company, and they pay taxes solely on a pass-through basis.
As for cons, the most significant one is the lack of legal liability protection: If your business is served with a lawsuit, you’re personally on the hook for it, with no way to shield yourself from risk exposure. Sole Proprietorships also make it challenging to transfer ownership or to bring employees on board.
Partnerships
A second option to consider is forming a Partnership.
In most respects, a Partnership works exactly as a Sole Proprietorship does. The only major distinction is that, rather than flying solo, you split duties, responsibilities, revenues, and liabilities with one or more business partners.
The Pros and Cons of a Partnership
As with a Sole Proprietorship, a Partnership offers pass-through taxation, a light regulatory burden, and ease of administration; while it provides less autonomy, it does allow the chance to share duties and risks with business partners, which some entrepreneurs may find appealing.
Also like Sole Proprietorships, Partnerships offer nothing in terms of personal liability protection, meaning entrepreneurs must live with a high level of risk exposure.
Limited Liability Companies
Another option is to establish your business as an LLC.
An LLC allows you to register your business as its own distinct legal entity, which means you can keep your personal assets and liabilities separate from any business assets and liabilities. This provides some built-in advantages, including a much more robust level of personal liability protection.
The Pros and Cons of an LLC
In fact, there are a number of benefits to the LLC format, including:
- Pass-through taxation (and therefore no double taxation, which is a big problem with Corporations).
- Safeguards against personal legal risk.
- Managerial flexibility.
- Options to transfer ownership and/or to bring partners into the business.
- A higher degree of professional credibility than what you’d experience with a Sole Proprietorship or Partnership.
- More opportunities to seek business loans and lines of credit.
As for cons, an LLC does require a little bit more setup and initial investment than other business structures. And unlike with a Corporation, an LLC does not offer the chance for you to sell shares and take the business public. This might make it more challenging to bring in third-party investors.
How to Register an LLC
The process for registering an LLC can vary by state, so always check state-specific regulations. Generally, the steps required include:
- Ensuring a business name not already in use by another LLC in your state.
- Appointing a Registered Agent. (See Northwest Registered Agent reviews for insight.)
- Complete Articles of Organization and file them with your Secretary of State.
- Pay your state’s registration fee (usually under $300).
- Claim an Employer Identification Number from the IRS (free).
- Create a business bank account, distinct from personal accounts.
Corporations
The final business structure to consider is the Corporation. A Corporation is a business model in which ownership in the company is determined by the selling of ownership shares. A Corporation is governed by a Board of Directors.
The Pros and Cons of a Corporation
Corporations are generally considered to be the most sophisticated business structure, which means there is a higher level of regulatory oversight. For example, when you establish your business as a Corporation, you are required by law to assemble a Board, to hold annual Board meetings, and to make regular public financial disclosures. Because this option is so onerous from a compliance standpoint, it is usually not the best bet for small business owners who wish to remain nimble and flexible.
With that said, Corporations do have significant pros, which include robust legal liability protections and the ability to court venture capitalists and other investors via the sale of ownership shares.
Note that Corporations are subject to double taxation, paying corporate taxes while shareholders pay additional taxes on their share of the revenues. This is another common knock against Corporations.
Which Business Structure is Right for You?
When it comes to choosing the right structure for your startup, there are a number of considerations to keep in mind. Some of these include:
- Level of autonomy and control
- Legal liability protections
- Ability to transfer ownership
- Taxation
- Ease and cost of initial setup
For many entrepreneurs, the LLC format provides the best middle ground, offering flexibility but also legal safeguards. Ultimately, though, this is a decision you’ll have to make for yourself, potentially in collaboration with a business coach or legal counsel.
Author Bio
Amanda E. Clark is a contributing writer to LLC University. She has appeared as a subject matter expert on panels about content and social media marketing.