4 Types of Businesses Every Future Entrepreneur Should Know
For the January IncubatorCTX Speaker Series, Albert Carrion, partner at Husch Blackwell, discussed what entrepreneurs need in their legal toolbox. One of the concepts he addressed was business structure and the benefits and drawbacks of each type.
A business structure is the type of legal structure you establish for your startup. It's important because it determines how your business will operate and who's responsible for what. There are four main categories of business structures.
View the U.S. Small Business Administration's guide to business structures.
Although not technically a legal entity, a sole proprietorship is the most common type of business structure. It's frequently used by one-person businesses and startups.
One of the top advantages of a sole proprietorship is that the owner has complete control over the business and decision making. Additionally, any profits go directly to the owner.
In the eyes of the law, the owner and the business are not separate. Therefore, the owner is personally liable, meaning that creditors can come after the owner's personal funds to pay off business-related debts.
While a sole proprietorship gives you full control of your business, you also have full responsibility to repay any debts.
A partnership is used when two or more people own and manage a business, equally sharing ownership. There are three types of partnerships, and each one has distinct advantages and disadvantages.
A general partnership is similar to the sole proprietorship in that all partners in the business are fully liable for any debts. All partners participate in managing the business, and all partners can be sued.
A limited partnership is combined with a general partnership. The limited partners are not involved in the daily operations of the business.
A limited partner is more like an investor who provides funds to help the business in exchange for a share of the profits. Their liability is limited to their investment in the business, while general partners maintain greater liability.
Limited Liability Partnership (LLP)
An LLP applies to a general partnership structure and provides limited protection from liability. Each partner manages their equal share of the business, and their personal assets are protected from negligence by other partners.
A general partnership has the same advantages and disadvantages of a sole proprietorship. A limited partnership is ideal for people who want to invest in a business while protecting their personal assets. An LLP offers better protection than a general partnership.
Limited Liability Company (LLC)
An LLC offers better protection of the business owners from personal liability. More formal than a partnership, an LLC is required to file articles of organization, which is a legal document that establishes the rights, responsibilities and liabilities between members.
The largest advantage of an LLC is that the personal assets of the owners are better protected from the business's creditors. Additionally, any entity apart from banks and insurance companies can form an LLC.
You don't have complete protection from liability. If you engage in fraudulent practices, you could be held liable for the business's debts. Additionally, if a member of the LLC leaves, the business must be dissolved, and the remaining members are personally responsible for any remaining debt. To keep operating, the members have to establish an entirely new LLC.
An LLC provides members with greater personal protection from liability, but it requires more documentation than a partnership and must be disbanded if a member leaves.
A corporation is the most complex type of business structure, but it offers owners (shareholders) the most protection because the business becomes a separate legal entity. Unlike LLCs, the business may continue to operate if shareholders leave.
To form a corporation, owners must file articles of incorporation that establish ownership, operations and other legal information. Corporations have many more legal requirements than other business structures, some of which include issuing stock, adopting by-laws, tracking shareholder meetings, and filing annual reports with the state.
For an entrepreneur, one of the greatest drawbacks of a corporation is the loss of control. Shareholders become owners of the company, and decisions must be approved by them, typically through elected board members.
There are two general categories of corporations.
C Corporation (C Corp)
A C Corp is typical of larger businesses looking to expand and raise capital. The C Corp has less restriction on how it issues stock (ownership). However, both the C Corp and its shareholders' dividends are federally taxed, resulting in double taxation.
S Corporation (S Corp)
An S Corp is most popular among small businesses. S Corps avoid double taxation, passing the profits or losses to shareholders who pay federal taxes just once. However, S Corps are much more restricted in the way they allocate shares.
Corporations are ideal for businesses that are looking to expand and for owners who are willing to relinquish total control of operations in exchange for the capital to grow. Owners are best protected from personal liability through corporations.
Whether you're interested in launching your venture as a sole proprietor or want to work toward forming a corporation, IncubatorCTX helps startups and new businesses grow.