Four business structure types and how to choose the right one

A business structure refers to the way an organisation is legally structured within a certain jurisdiction. When starting a business, it is imperative that you choose yours carefully.

The business structure you choose will impact how much you are taxed, how much personal liability for the business you take on, and the actions your business is allowed to take. For example, some structures tax your business very heavily when others do not.

The four main business structure types are:

• Sole proprietorship
• Partnership
• Limited liability company (LLC)
• Corporation

In this guide, we will walk through each of these business structures and help you choose the one that best aligns with your goals.

• What goes into choosing a business structure?
• Four business structure types
• Sole proprietorship
• Partnership
• Limited liability company (LLC)
• Corporation
• S corporation
• C corporation
• B corporation
• Close corporation
• Nonprofit corporation
• Considerations to keep in mind when choosing a business structure
• Prioritise personal safety and long-term success

What goes into choosing a business structure?

There are some important considerations that should be top of mind as you decide on your business structure:

• Liability: How much risk are you willing to personally take on for your business? While certain business structures offer liability protection, others leave you and your personal assets vulnerable to lawsuits and creditors.
• Complexity: Are you looking for the path of least resistance as you get started, or are you interested in a more authoritative and complex structure?
• Growth timeline: If you anticipate starting small and taking your time to grow as a business, you’ll likely choose a different structure than if you anticipate rapid growth and profitability.

Next, we will review the four most common business structures and explain how to decide between them.

4 business structure types

As we’ve already established, there are four common types of business structures with varying degrees of formality that you should be aware of before making a decision. We explain them below.

Sole proprietorship

Unless you file paperwork to choose a different business structure from the beginning, you start your business as a sole proprietor by default. A sole proprietorship is the simplest business structure there is, as one individual is responsible for all of the business’s tasks.

This informal structure doesn’t make your business its own entity – your business is an extension of you. Here’s what that means:

• Structure: There is no legal difference between you as an individual and your business. All your business’s assets and liabilities exist under your own name, even if you operate the business under a different name by filing a fictitious business name (also known as a DBA, or “doing business as”).
• Liability: If your business is ever sued, your personal assets will be at risk. This includes your house, property, and savings. Loan approval is also based on your personal credit history and assets, and you are solely responsible for paying off loans (even if your business can’t afford to do so). For this reason, a sole proprietorship is considered a risky business structure to operate under.
• Taxes: Taxes for sole proprietorships are reported on your personal tax returns. This means you won’t be able to take advantage of some of the tax incentives offered by other business structures. You must file Form 1040, which must include Schedule C and Schedule SE for self-employment tax.

Advantages: The benefits of starting a sole proprietorship include the low cost compared to other business structures and the ease of operations. Business taxes and operating license fees tend to be the only costs you’ll have to worry about. This makes it a great option for new business owners without much capital.

Disadvantages: Of course, the biggest downside is the personal liability you take on with this structure. If the business fails, it comes entirely at your expense. There are also certain tax benefits that only more formal business structures can reap.

Partnership

A partnership shares most of the same qualities as a sole proprietorship, except it has two or more owners. Just like a sole proprietorship, the owners and the business are legally considered the same entity.

While a partnership shares the same qualities of a sole proprietorship listed above, it has the following tax differences:

• Forms/reporting: Each partner reports the information in Form 1065 with their personal tax returns. Schedule K-1 must accompany Form 1065 in a partnership, since it documents each partner’s income, losses, and dividends.
• Payment arrangement: Partners report their share of profit or loss on their income tax return. The self-employment tax that partners pay depends on their share of the company’s profits.

Advantages: Similar to sole proprietorships, partnerships enjoy the benefit of minimal paperwork and ease of operation. Having more than one person connected to the business also reduces individual liability, as risk is split between the partners.

Disadvantages: Aside from the obvious downside of the partners still carrying all the liability for the company (unlike a limited liability company or corporation), partnerships provide room for disagreement. Multiple owners means multiple opinions about business strategy and direction, which can cause clashes.

Limited liability company (LLC)

A limited liability company (LLC) is a formal business structure that falls somewhere in between a partnership and corporation. This structure offers personal liability protection comparable to a corporation while also allowing less formality and paperwork than a corporation.

• Structure: Unlike a sole proprietorship or partnership, an LLC is a separate entity from its owner(s). There is no maximum number of owners, and owners have a full participatory role in the business’s operation.
• Liability: Much like a corporation, an LLC’s assets are separated from your own personal assets. If your business faces bankruptcy or is sued, your personal assets as an owner are protected.
• Taxes: You have flexibility in how you will be taxed. For example, you can structure your LLC to be taxed as a C corporation, or more commonly, as an S corporation (where the business doesn’t file its own taxes). Owners do not need to pay corporate taxes, but they must pay self-employment tax contributions toward Medicare and Social Insurance.

Advantages: One of the most significant benefits of an LLC is personal liability protection – you don’t need to worry about your home being confiscated if your business goes bankrupt. It’s also the easiest way to attain this protection – there’s less paperwork and bureaucracy than is involved when establishing a corporation.

Disadvantages: The main disadvantage is the investment required to gain these benefits. Starting an LLC is more expensive and time-consuming than starting a sole proprietorship or a partnership. It’s also advisable to hire an attorney and an accountant to ensure the business is compliant with regulatory requirements.

Corporation

A corporation is the most complex formal business structure. Like an LLC, a corporation is a legally separate entity from you as the business owner.

• Structure: A corporation is highly complex. Once you register your business as a corporation, you are required to set up a formal structure consisting of shareholders, directors, and officers, all of whom need to be recorded in your official corporation paperwork.
• Shareholders, who may also be owners, receive a portion of the company’s equity.
• Directors make strategic decisions through the board of directors.
• Officers manage the day-to-day activities of the company.
• Liability: The corporation is responsible for all of its own debts and liabilities, and your personal assets can never be touched to cover business obligations. This “corporate shield” protects your personal assets from being taken on behalf of the business.
• Taxes: Because your corporation is considered a separate entity from you, it will need a separate tax return.
• Investment: If you plan to seek funding from venture capitalists, a corporation is the preferred business structure.

Advantages: An obvious advantage of starting a corporation (similar to an LLC) is the personal liability protection that it offers. This structure protects you and your assets from company debts and other liabilities. Another key benefit is the ability to raise money by selling shares of stock. To go public on the stock exchange, a business needs to be incorporated as a corporation.

Disadvantages: That said, corporations are complex and costly. You must comply with stringent tax requirements and regulations compared to less formal business structures. This is why most corporations hire attorneys to keep themselves legally compliant.

If the prospect of starting a corporation interests you, you’ll want to choose the best corporation type for you. Next, we’ll talk through the various corporation structures and what they mean.

S corporation

Advantage: Pass-through taxation/no chance of corporate “double taxation”

Disadvantage: Maintaining S corporation status can be challenging

Many small businesses choose the S corporation, or S-corp, which does not file its own taxes. Instead, company profits are “passed through” the business and reported on your personal income tax return, as well as that of other shareholders.

As an S-corp owner, you are taxed on your respective shares of the company’s profits, and those profits are not subject to self-employment tax. You can also pay yourself a salary as an employee of the S-corp.

C corporation

Advantage: Ability to sell more than 100 shares of stock

Disadvantage: Double taxation

Another type of corporation is the C corporation, or C-corp. C-corps offer limited liability protection, but come with the added advantage of being able to sell more than 100 shares of company stock.

The main drawback is tax-related. Any profit made by a C-corp is taxed twice. Upon realising the profit, a C-corp must pay taxes on it. When those profits are passed onto shareholders, the shareholders must pay an income tax on those same profits.

Benefits corporation

Advantage: Improved reputation and business opportunity

Disadvantage: Maintaining B-corp status is challenging

While still a for-profit corporation, a benefits corporation, or B-corp, is a designation given to businesses that demonstrate commitment to purpose, accountability, and transparency. Some procedures that can earn a business this designation include excellent employee benefits, charitable giving, and responsible supply chain practices.

B-corps are taxed the same as C-corps, but they are driven by more than just profit. Shareholders expect the company to create some type of public benefit in addition to pursuing profit.

Close corporation

Advantage: Less formal/complex

Disadvantage: Inability to trade shares publicly

Close corporations operate similarly to B-corps, but do not adhere to the formality of the traditional corporate structure. They tend to be smaller than most corporations and don’t require a board of directors to operate.

Despite the benefit of less bureaucracy and fewer regulations, close corporations usually cannot trade shares publicly. For this reason, it’s not the best choice if you’re looking to accrue lots of capital.

Non-profit corporation

Advantage: Tax-exempt

Disadvantage: Must follow special rules for using profit

Non-profit corporations are those that perform charitable, educational, social, scientific, or religious work. These corporations gain tax-exempt status for doing specific types of work, meaning they don’t have to pay state or income taxes for their profits. However, to gain this status they must first file with the IRS.

While they follow many of the same organisational rules and procedures as C-corps, non-profit corporations must also follow special rules about how they use their profits. For example, profits can’t be used to fund political campaigns.

Considerations to keep in mind when choosing a business structure

Now that we’ve reviewed the most common business structure types, it’s time for you to make a decision. The following considerations will help you choose the right business structure based on your available resources and goals.

Anticipated risk

The higher the risk, the better it is to choose a formal structure like an LLC or a corporation. Otherwise, your personal assets are placed in serious danger. 

If you feel confident that your business will have a very low chance of liability and financial loss, then it’s worth considering a sole proprietorship or partnership. If you don’t feel so confident, it’s probably worth investing in the personal liability protection offered by LLCs and corporations.

Budget

Starting a formal business is expensive, so it’s important to have plenty of cash set aside if you plan to pursue this route. If you don’t have the budget for it, you should consider first starting a sole proprietorship or partnership. Remember, you can always register your business as an LLC or a corporation at a later date.

That said, if you have sufficient funds and are looking to gain the benefits offered by a formal business structure, consider an LLC or a corporation.

Expected (and desired) growth

Corporate taxes are expensive. If you don’t expect to make enough money to make a corporate tax structure worth it, you’ll likely want to pursue an informal business structure. 

However, if you plan to make immediate, sustainable profit and develop a large customer base, you may find a formal business structure like a corporation beneficial. Formal structures like corporations are also more likely to be perceived as credible and trustworthy, allowing for more investment opportunities and a larger customer base.

Time and effort

Maintaining a corporation is more challenging than maintaining any other business structure. It requires formal mechanisms, lots of paperwork, and regular meetings to survive. It also often requires solicitation of help from investors.

Informal business structures and LLCs are far easier to create and maintain. Neither require a board of directors or regular meetings to exist. If you’d prefer to avoid paperwork and bureaucracy, you’ll probably want to pursue one of these options.

Prioritise personal safety and long-term success

Starting a business is a challenging and risky endeavor, but it can also be incredibly rewarding. As long as you plan ahead and move cautiously, you have the opportunity to create something great.

Once you’ve used this guide to map out your business structure, turn to QuickBooks’ business solution to help with your finances as you get your business off the ground. We take the headache out of financial management so that you can focus on making your business thrive.