The world of business and finance is confusing. If you’re just starting out, it can be really confusing. However, you’re far from alone. Over a million businesses started in 2020, and the number seems to be on an ever-increasing track.
One of the most complicated and yet consequential decisions you’ll make at the beginning is choosing your business structure. Luckily, knowing the differences between these structures, including their advantages and disadvantages, puts you in the best position to make the right decision!
There are a few options to pick from, so let’s go through them and help you figure out what works best for you and your new kick-starter!
Partnership
A partnership is a business structure in which multiple people partner together to run a business, distributing the profits, as well as liabilities, among the partnership as they see fit, in most cases equally. They are also held liable for debt and obligations of their company as well as the actions of other partners.
Each partner will be responsible for keeping track of their individual share of profits and losses to report to the IRS to pay self-employment taxes. This option is appealing to a group of like-minded entrepreneurs sharing a similar vision for a company, preferably with some complimentary skills if you’re just starting out. It certainly isn’t right for every business.
While a partnership can be as simple as a verbal agreement based on the honor system between two friends, written entities are more common and much safer for the parties involved.
Sole Proprietorship
This is the most simple option for somebody starting a business. Not only that, it’s the most common! In fact, over 73% of businesses in the US are considered sole proprietorships!
The structure is easy enough to understand. The person at the top, the owner, is solely responsible for all debts and liabilities involved with the company, as well as all profits.
With a sole proprietorship, you can pay your taxes through regular income tax if you choose to pay yourself a salary. This is a great option if you don’t want to have to save up a big lump sum for tax time every year, and would rather have it taken out of a paycheck more frequently.
However, you will still have to pay additional self-employment taxes and keep track of all business expenses and revenue for the IRS. So you can choose to use company money for personal expenses and pay all your taxes at the end of the year, or pay yourself a salary and just pay taxes on the remaining profits at the end of the year.
Limited Liability Company (LLC)
Another option, and one of the newest in the business world, is an LLC. This is a business structure in the United States in which the owners are not personally liable for the company’s debts or liabilities, freeing you from some of that burden. While this sounds appealing right off the bat, there’s more to it than that.
Not every business can be considered an LLC, so you need to find out if the structure is right for what you’re doing. In fact, certain businesses are even excluded from this structure, especially in the financial sector, because of the limit to liabilities of the owners. Learn about the advantages of an LLC.
Corporation
Like every structure, this comes with many advantages as well as disadvantages. Incorporating your company does relinquish some control over it to a board of directors, as well as shareholders of the company, who invest their money while expecting a solid return. This gives them some control over your business’s regular operations, without you ever even hiring them!
A corporate structure has many advantages as well. It opens up your company to the public, including those very investors and the funds they’ll bring with them! This can stimulate rapid growth by providing greater funds to expand your business.
When they buy shares of your company, the value goes up, offering an increase in the value of whatever amount of the company you already own.
Once you make an initial public offering (IPO), the market, consisting of a wide range of investors, will decide to buy shares of your company or not, if they value the potential of your company at a higher amount than your initial offering. They buy shares with the hope is that their instincts are correct, your company will grow and expand, becoming more valuable over time, and they will receive a return on their investment.
The institution is famous for having presidents/CEOs, but there is a board of directors responsible for decision-making. Policies are then carried down from the top to lower levels of management, then down to the workforce.
Corporations are also set to follow different laws in different states and are also taxed as a separate entity with specialized tax rates. This also carries with it specialized tax advantages and deductions, which is appealing to many.
How to Choose a Business Structure
Well, to put it simply, there is no magic formula. Each of these options exists because they have intended purposes for different businesses, people, and interests. However, what you choose will have lasting consequences for the future of your business, so choose wisely!
The good news is, whatever business structure you choose is not set in stone. If you start out with a sole proprietorship and choose to incorporate years down the road, that option will always be available to you. Now that you know the basics of the different business structures, get your business up and running today!
