Business structure is an important factor to consider when starting a business. The importance is in regard with the fact that the amount of taxation on a business, the ability of the owners to raise capital, paperwork filing, and personal liability are all elements that are important to a business owner. The elements vary across different business structures. A prospective owner with concern about the aforementioned elements would inevitably have to factor them into his or her decision making. In turn, the elements would lead him to a choice of one of the available business structures – sole-proprietorship, partnership, LLC, and corporation.
Sole-Proprietorship
A business person is considered operating in sole proprietorship if he or she does a business activity, and has no any other business registered (Cooper, 2016). It has the characteristic of being easy to form and gives its owner full control of the business.
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However, with sole proprietorships, the business is not legally considered as an entity separate from its owner. Strictly speaking, the owner’s personal assets are not distinguished from the business’ assets (Cooper, 2016). The owner is subject to liability for the business’ obligations and debts.
Sole proprietorship businesses are able to acquire a trade name. However, as they cannot sell stocks, and as financial institutions tend to be hesitant to lend them money, businesses structured as such encounter the problem of raising initial or working capital (Cooper, 2016). Owners have to turn to alternate means, which may be more difficult. Sole-proprietorships, however, affords an opportunity to prospective entrepreneurs who are afraid of high risks or simply want to put their business idea to test. In that regard, they can be a good precursor to more formal businesses.
Partnerships
For businesses involving more than one owner, a partnership is the simplest business structure. The structure is mainly categorized into two: LP, or liability partnership; and, LLP, or limited liability partnership. With LP, only the liability of one partner – referred to the general partner – is limited, while, with the latter, all partners’ liabilities are limited (Cooper, 2016).
The difference between the two categories relies on the liability of partners. Business control by the general partner is not limited, compared to that of partners with limited liability. Profits pass to personal tax returns (Cooper, 2016). The partner with unlimited liability is subject to self-employment taxation. As for liability partners, each partner has limited liability and the LLP business protects its owners from debts related to the business (Cooper, 2016). Partnerships are an appropriate option for businesses owned by more than one person, and a group of people who want to test their idea’s feasibility prior to starting a more formal business.
Limited Liability Company
A limited liability company, or LLC, brings together the pros of partnership and corporation business structures. The LLC structure protects the owner from personal liability in most cases (Hausermann, 2011). For instance, personal assets like savings account and property would not be at risk in case of a lawsuit or bankruptcy of the business. In terms of taxes, losses and profits are passed to the owner's personal income (Hausermann, 2011). The business does not face corporate or profit tax. However, the law considers its members self-employed, and, as such, they have to contribute self-employment tax to Social Security and Medicare (Hausermann, 2011).
An LLC has a limited lifespan. The act of a member joining or leaving an LLC may require the dissolution of the business and reformation with the new member, as per some states (Hausermann, 2011). An exception is allowed only if an LLC has in place an agreement selling, buying, and ownership transfer (Hausermann, 2011). An LLC business structure is a recommendable option for a business that is a medium risk or high risk. It may interest owners with substantial personal assets they do not want to risk, as well as those who want to pay less taxes than would be the case of a corporation.
Corporation
If a business has a corporation as a structure, the law considers it a legal entity separate from the people who own it. Corporations can make a loss or profit, and it is the business that is taxed and held legally liable, rather than the individuals that formed or own it (Tricker, 2015). As such, owners are more strongly protected from personal liability than in other business structure. Moreover, the exit of a member or his or her sale of his or her shares does not disturb the operation of the business (Tricker, 2015). However, the cost of formation is significantly higher compared to other structures, as well as extents of operation processes, record-keeping, and reporting.
In terms of taxes, businesses structured as corporation pay tax on their profit (Tricker, 2015). This creates the possibility of double taxing in some cases: when the business makes a profit, and when shareholders are paid dividends. Shareholders are taxed on their income. Because corporations can raise capital via the sale of stock, the structure is a good choice for businesses that may need to raise money at some point in their lifespan. It also makes a good choice for high risk and medium risk business, as well as those that may be intended to ‘go public’, or be sold in the end.
What Business Structure to Choose
From the perspective of a prospective business owner, an ideal business structure would be that which is easy to start, capital is easy to raise for, offers limited liability, is taxed lowest, is not susceptible to dissolution, and offers its owner sufficient control. If the objective is to start one’s own business, partnership structure is automatically excluded. In terms of ease of forming, sole-proprietorship is recommendable. The structure also offers the owner full control of the business. In terms of raising capital and limitedness of liability, a corporation would be preferable. However, corporations are complex to run, and they are also taxed twice. The remaining structure, LLC, is taxed more highly than sole-proprietorship. Hence, sole-proprietorship would be most recommendable for anyone who wants to start his or her own business.
References
Cooper, M., McClelland, J., Pearce, J., Prisinzano, R., Sullivan, J., Yagan, D., ... & Zwick, E.
(2016). Business in the United States: Who Owns It, and How Much Tax Do They Pay?. Tax Policy and the Economy , 30 (1), 91-128.
Hausermann, D. M. (2011). For a few dollars less: explaining state to state variation in limited
liability company popularity. U. Miami Bus. L. Rev. , 20 , 1.
Tricker, R. B., & Tricker, R. I. (2015). Corporate Governance: Principles, policies, and
practices . Oxford, UK: Oxford University Press.
