The Essential Guide to Types of Business Ownership: From Startup to Established
Thu | June 2024
Starting a business is exciting, but there are many decisions to make. Choosing the right business structure is crucial for your success. It can impact your finances in several ways, including protecting your personal assets (liability) and potentially reducing your tax burden.
Many entrepreneurs start with a DBA (Doing Business As) for simplicity. This can be useful as a transitional arrangement, but it's usually wise to switch back to something more suitable once your business takes off.
This article covers everything you need to know to navigate different ownership structures in the US, and how to make the most appropriate choice for your business.
Understanding Ownership Structures
What is an Ownership Structure?
A "business ownership structure" defines who owns and controls a business. Is it just you, you and a partner, or a big group of shareholders? Shareholders invest money in a corporation in exchange for a share of ownership. You've probably come across the main ownership structures before:
Sole Proprietorship: An individual owns the business.
General Partnership: Two or more individuals own the business.
Limited Liability Company (LLC): Owned by one or various members.
Corporation: Owned by its shareholders (investors who own a piece of the company).
Ownership vs. Business Entity
Think of an ownership structure as the person who owns the house and the business entity as the legal form the house takes. In other words, ownership structure defines who controls the business, while the business entity determines how the company is structured legally. This impacts things like taxes and liability.
For example, a sole proprietor like John Doe can operate under a different business name, ABC Plumbing, using a DBA (Doing Business As). Here, John Doe (ownership structure) is the sole owner, and ABC Plumbing (business entity) is the business's legal form, with a different public name. The ownership structure (John Doe) remains the same, but the business entity has a different public face (ABC Plumbing).
We'll cover the details of each structure later in this article, including their pros and cons and how they differ in terms of business entity.
Key Considerations When Choosing a Structure
Choosing a business ownership structure is about far more than ownership or technicalities. Here are some of the most essential elements to consider:
Liability. If a business faces debts or legal issues, who is responsible? Limited liability allows owners to separate their assets from their business, while unlimited liability means no separation.
Taxes. Different ownership structures are subject to different taxes (e.g., personal taxes, corporation taxes, and dividend taxes).
Management. Ownership structure dictates who has decision-making authority in a business. Can a single owner dictate the company's direction, or is there a larger group who all get a say?
Growth Potential. Some business structures facilitate growth, allowing businesses to issue shares to raise capital for investment. Others are more limited.
Moving from a DBA to a More Formal Business Structure
As mentioned, operating under a DBA can work as a temporary arrangement. It allows you to start a business with minimal hassle — instead of formally registering a company, you can simply choose any trade name or alias while operating under a sole proprietorship or partnership.
However, this is a risky approach over the long run. You won't create a separate legal entity, meaning your assets will be vulnerable if you encounter a financial or legal issue. The US is infamously litigious, with 36% to 53% of small businesses being sued every year.
Graduating a business from a DBA to a formal ownership structure has the following advantages:
Limited Liability Protection: Protect personal assets from business debts and lawsuits.
Possible Tax Advantages: Depending on your business structure, there may be tax advantages to consider. For example, S corporations are pass-through entities, meaning profits and losses pass through to the owner's tax return, potentially reducing tax burdens. However, C corporations are taxed twice, once on corporate profits and again on dividends paid to shareholders.
Credibility and Growth Potential: Enhance the professionalism of your business, which can help to attract investors.
Common Types of Business Ownership in the US
We'll now explore the intricacies of each common business structure, considering both ownership and legal form (business entity). This will help you understand how the structure you choose impacts factors like liability, taxes, and control.
Sole Proprietorship
A sole proprietorship is the simplest structure on this list. Setting one up is easy and inexpensive, and running one involves minimal regulatory requirements. Since there's a sole owner, this person retains complete business control. This makes it an excellent choice for those starting one-person businesses, such as:
Freelancers
Consultants
Small service businesses (e.g., personal trainers)
However, a sole proprietorship has limitations to consider:
Vulnerability of Assets. No legal separation between your business and personal assets exists. If your business faces a lawsuit or accumulates debt, your personal belongings (car, house, savings) can be used to settle those debts.
Sole Proprietorships Face Limited Growth. They can't sell shares for capital. This lack of separation between business and personal assets makes lenders wary. Also, managing a growing business alone is hard.
A sole proprietorship offers simplicity. But, you must consider these limits when choosing your business structure.
General Partnership
Similar to a sole proprietorship, a general partnership involves running a business. However, the key difference is that two or more partners share ownership and management. This allows partners to combine strengths. Partners can pool their money, skills, and experience, creating a stronger business foundation.
Picture a marketing specialist and a web developer starting a digital marketing agency. They create a clear partnership agreement. It outlines how profits and losses will be shared based on their contributions. This ensures fairness and balance in their partnership. A partnership agreement is not required, but it is recommended to minimize potential conflicts down the road. This document outlines key aspects like:
Profit and Loss Sharing. As defined in the partnership agreement.
Roles and Responsibilities. Who handles specific areas of the business (finances, marketing, operations)
Decision-Making. How decisions are made (majority vote, unanimous consent, etc.).
General partnerships offer benefits, like combined expertise and a simpler structure. But, they have limitations to consider:
Unlimited Liability: All partners are personally liable for business debts and obligations. This means even if one partner makes a mistake (e.g., negligence leading to a lawsuit), it can expose all partners' personal assets (car, house, savings).
The concept of unlimited liability is an essential consideration for general partnerships. Consider the pros and cons of a general partnership. This step will help you decide if it fits your business. If you aim for limited liability and growth, consider LLCs or corporations.
Corporation
A corporation is the most complex structure, usually reserved for larger organizations. As mentioned, a corporation is owned by its shareholders, so this structure only makes sense for a company that has scaled to the point of bringing on investors.
This opportunity to fundraise offers a lot of growth potential. Corporations also have limited liability, so there's no need to worry about losing personal assets. These structures make the most sense for a variety of businesses, including:
High-growth startups
Established companies planning to go public
Firms seeking prestige or investment
However, corporations have responsibilities to their shareholders and must follow specific formalities. Shareholders have a voice in the corporation through their ability to elect a board of directors. The board of directors holds significant legal authority and oversees the corporation's management to ensure it operates in the best interests of the shareholders.
Leading a company requires navigating complex rules. The company also has a rigid structure and faces double taxation on profits.
Limited Liability Company (LLC)
An LLC is often known as a "hybrid structure" since it combines elements of a corporation and a general partnership. Like a corporation, it offers limited liability protection for its members (owners). However, as with a general partnership, it can benefit from pass-through taxation, giving you the best of both worlds.
Benefits of an LLC:
Limited Liability Protection: Like a corporation, LLCs shield members' assets from liability in case of business debts or lawsuits. LLP is a crucial advantage over sole proprietorships or general partnerships.
Pass-Through Taxation: LLCs benefit from pass-through taxation, similar to a partnership. The LLC's profits and losses pass directly to the members' personal tax returns, avoiding the double taxation that corporations face.
Management Flexibility: LLCs offer flexible management. Members can choose to manage the company themselves or appoint an outside manager.
Who can benefit from an LLC?
LLCs are well-suited for a variety of businesses, including:
Businesses with multiple owners (who want to share ownership and profits while limiting personal liability)
Early-stage startups or businesses
Creative agencies
LLCs are generally cheaper to maintain than corporations. However, they may have slightly higher fees than general partnerships due to filing and maintenance requirements that vary by state.
Choosing the Right Structure for You
Below is a table summarizing the key differences from each business structure.
Sole Proprietorship | Partnership | LLC | Corporation | |
Liability | Unlimited | Unlimited | Limited | Limited |
Taxes | Pass-Through | Pass-Through | Pass-through or Corporate | Corporate |
Control | Owner | Partners | Members | Board of directors |
Growth Potential | Limited | Limited | Moderate | High |
Ease of Formation | Simple | Simple | Moderate | Complex |
You can also access further resources online, such as the SBA website and the rest of the One Park Financial blog.
However, consulting a legal or financial professional for guidance tailored to your unique circumstances and business needs is always best.
DBA is So Yesterday
The business ownership structure you choose can make or break your business. Making the correct choice enables companies to optimize taxes, maximize growth potential, and protect personal assets.
Continuing to operate as a DBA could result in losing everything in a nasty lawsuit. Choosing a more suitable business structure could mean seeing your business reach its full potential.
Disclaimer: The content of this post has been prepared for informational purposes only. It is not intended to provide and should not be relied on for tax, legal, or accounting advice. Consult with your tax, legal, and accounting advisor before engaging in any transaction.