Whether you’re just launching a business, or growing an already successful one, you need to ask yourself a very basic question: how should I structure my business? Am I running a sole proprietorship, a partnership, an LLC or a corporation?
Knowing what type of business you have – or want to have – is essential for legal and financial reasons. It will affect how you can access funding, how you pay taxes, salaries and the types of contracts and legal papers you need to file. Its not something that you want to guess about, as making the wrong decision can leave you open to legal liabilities that could be devasting.
Types of Businesses
A small business is likely to be either a sole proprietorship, a partnership, a limited partnership or a limited liability company (LLC). But you may be running a nonprofit organization or a cooperative (Co Op). It’s unusual, but not unheard of, for a small business to be a corporation, but we’re including details just in case you’re considering that business structure.
If you own and run your business, and have no partners, you are probably running a sole proprietorship. This is the simplest, and the most common structure chosen by new small business owners. One thing to be aware of though is with a sole proprietorship, there is no distinction between the business and you, the owner. You get all the all business profits and you are also responsible for all of the business’s debts and liabilities and legal issues. So, if your business gets successfully sued your personal assets could be part of the settlement.
And while you may hear that you can simply become a sole proprietorship just by launching a business, you may need to register the business name (even if it’s a simple “Doing Business As” form also known as a DBA) with your state to get a business license which you’ll likely have to show to open a business bank account. You’ll also need to have any permits or licenses associated with your type of business. Note that it can be difficult to raise funding when you are a sole proprietor, you cannot sell stock in the business, and banks tend to assume a sole proprietorship is too high risk for loans.
If your business is owned by two or more people, you may want to form a partnership. You can divide up the percentage of the actual business ownership in various ways- you don’t need to use a 50%-50% model. You will need to register your business with your state (or a state you are doing business in) and the IRS and obtain a business license.
There are two common kinds of partnerships: limited partnerships (LP) and limited liability partnerships (LLP). LPs have only one general partner with unlimited liability, all other partners have limited liability and – typically, limited control over the company. Also, the partner with unlimited liability pays self-employment taxes. Profits are passed through to personal tax returns. LLPs assign limited liability to every owner, enabling each to be equally protected from debts against the partnership.
Forming a partnership may work for you if your business has multiple owners or you are working with a professional group (for example; an artists’ collective or a legal or medical practice with multiple professionals). You may also find it easier to raise funds with a partnership, although banks are typically resistant towards providing loans to any type of small business.
Limited Liability Company (LLC)
An LLC gives you some of the benefits of both the corporate and partnership business structures. In an LLC, partners are referred to as “members.” Each member’s personal assets are protected, in most cases, against business bankruptcy or lawsuits. The business’ profits and losses can be passed through to member’s personal income with being affected by corporate taxes. However, members of an LLC are considered self-employed and required to pay the self-employment tax for Medicare and Social Security.
If the business you are involved with has a small group of owners, a medium- or higher-risk of litigation, or you/other members have significant personal assets to protect, an LLC may be the right choice for you. LLCs are also a good option for larger businesses who don’t want to deal with the legal complexities and tax rates associated with operating a corporation. Note that some states require LLCs to be dissolved and reformed if members leave the group, unless there is a legal agreement in place that details how buying, selling and transferring ownership will be handled.
LLCs can be a good choice for medium- or higher-risk businesses, owners with significant personal assets they want to be protected, and/or owners who want to pay a lower tax rate than they would with a corporation.
A corporation is comprised of multiple shareholders who hold stock in the business. It is a legal entity that is separate from its owners. Corporations offer strong protection from personal liability but are the most expensive types of businesses to form. Corporations also require significantly more extensive record-keeping, operational processes, and reporting than other business structures.
Unlike sole proprietors, partnerships, and LLCs, corporations pay income tax on their profits. With a C corp (the most common type of corporate structure) profits may be taxed twice —on the initial profit, and then again when dividends are paid to shareholders.
Forming a corporation may be a good choice for businesses that plan to grow rapidly, issue stock, and ultimately “go public” and be bought out. There are several types of corporations you can form, and it’s important to consult with a business attorney to figure out how to form a corporation, and what type to form, as the process is complicated and costly.
If your business’ purpose is performing charitable educational, religious, literary, or scientific work for the benefit of the public, and profits are used by the organization to pay for its expenses, programs, charitable giving and other associated purposes, you may qualify as a nonprofit. To gain tax-exempt status you fill paperwork, including an application, with the IRS. In fact, nonprofits are often called 501(c)(3) corporations —which refers to the section of the Internal Revenue Code commonly used to grant tax-exempt status. As a nonprofit, your company follows organizational rules that are very similar to those of a standard C corp, along with special rules governing profits.
A cooperative is a business that's owned and operated for the benefit of the members of the organization. So, whatever monies the cooperative earns is shared among the members, all of whom have a say how the cooperative manages its business operations. A cooperative must have bylaws, formal membership applications, a board of directors, and regular member meetings.
Funding your small business
Bigger businesses have more options when they need to raise money than small businesses do. owners of smaller businesses often struggle to access working capital from bank loans – the application process is complex and demanding, and requirements are strict. You may not have the time, know-how, patience or credit history to qualify for the same financing options that were designed to meet the needs of big businesses.
One Park Financial works to help owners of small and mid-sized businesses access the working capital that they need. Our process is simple and straightforward, and we’ve helped many small businesses who have been turned down by banks to access funding. Visit oneparkfinancial.com or call 855.218.8819 to discover the options that make sense for you and your business.