Understanding Business Structures & Their Various Use Cases

The legal structure you choose for your business will impact every aspect, from taxation to licensing and liability. There are several business structures to choose from. But as startups, you may only need to understand the three most common types; sole proprietorship, limited liability companies (LLCs), and corporations. 

This guide delves into these three business structures, from their composition to the various use cases, so keep reading to learn more if you are contemplating starting a business.

Sole Proprietorship

A sole proprietorship is the most basic form of business structure. As the name suggests, it is a business owned by one person. A sole proprietorship has several advantages; it is simple to set up because it has minimal formalities. 

Secondly, the business owner is also the sole decision maker, making decision-making quicker since consultation is unnecessary. It also comes with tax flexibility, such as special tax deductions for small businesses and access to some forms of credit designed for small businesses.

On the flip side, the structure doesn’t distinguish between personal and business property. So the business owner is responsible for business debts and liabilities. In other words, your personal property can be sold to pay business debts and liabilities. Other disadvantages include limited resources, expertise, and business growth and expansion challenges.

The unlimited liability aspect of a sole proprietorship is the reason it is a significant concern for most businesses, and it should be for you. So before choosing this option, it is best to talk to an expert to learn all the details.

Limited Liability Company (LLC)

 An LLC is a mid-tier business structure that incorporates the best of sole proprietorship and the upper-tier corporation type of structure. As the name suggests, this business structure distinguishes between personal and business property, thus offering limited liability protection. 

You can start an LLC as a single business owner or with partners. If you are a single owner, you will form a single-member LLC. For partnerships, you will need to form a multiple-member LLC, which also requires creating an operating agreement.

However, LLCs formed in Florida, Texas, or any other US state, excluding California, Delaware, Maine, Missouri, and New York, are not required to create an LLC Operating Agreement. However, regardless of the state you’re in, it’s always a good idea to establish a formal agreement among LLC members.

You may wonder, what is an operating agreement for an LLC? It is illegal documentation stipulating the rights and obligations of each member of the LLC.

Advantages of an LLC

Most businesses in America are registered as LLCs for one main reason; separation of business and personal property. Secondly, LLCs enjoy the benefits of pass-through taxation. Pass-through taxation is a tax structure where business profits “pass-through” to the owners’ tax returns rather than having a business’s profits taxed, avoiding double taxation. 

While not as simple as forming a sole proprietorship, forming an LLC is significantly easier and less expensive than creating a corporation. Also, LLCs lend significant credibility to a business which is a plus when working with clients, customers, lenders, and professionals.

Disadvantages of an LLC

While LLCs enjoy pass-through taxation, members are subject to self-employment taxes. Also, LLCs can have limited growth opportunities compared to corporations due to limited options for raising capital. 

In some states, setting up an LLC can be quite hectic, which can be a huge hindrance, but when contrasted with its benefits, LLCs are the better option if you have to choose between it and a sole proprietorship.

Corporations

Cooperation is the most complex form of business structure. Corporations are businesses owned by a group of individuals but work as a single entity. The members of a corporation are known as shareholders. 

Advantages of a Corporation

The main advantage of a corporation is that it offers its members the highest form of protection against liability. 

There are more opportunities for growth for corporations than in other forms of business structure because of the possibility of raising capital through selling stock. 

Transfer of business ownership is also pretty straightforward since a member only needs to sell their shares to exit a business.

Disadvantages

The most significant disadvantage of a corporation is the complexity and the high cost of creating one, making it only suitable for big businesses. 

Also, shareholders have minimal control over the company’s running. The government also closely monitors corporations, resulting in increased legal and compliance costs.