Choosing the right structure for your small business maybe challenging. There are various types of business entities, and each has its own advantages and disadvantages. This article will outline the good and the bad of each business structure, and hopefully after reading it you will be able to choose the right business structure for your small business.
SOLE PROPRIETORSHIP
A sole proprietorship is the simplest business structure. It is owned by one person and there is no legal distinction between the owner and the business. All profits and losses are belong to the owner, and are subject to taxation. This business type is commonly used by freelancers and other service professionals. It is also used by many small businesses in different industries e.g. restaurants, farmers, supermarkets, transport business e.t.c.
Advantages
- Easy to start and set up as there is no complex documentation needed
- Easy to terminate since the business owner has full control over the business
- Cheapest type of business to start and operate. It has the lowest set-up costs and ongoing fees.
- All the profits of the business belong to the owner
- Net business losses can be deducted from your personal taxes
- It has few reporting requirements, which means less administration work.
- Owner is free to make own decisions concerning the business operations.
Disadvantages
- The owner is personally liable for all the debts and liabilities incurred by the business. If the business does not have enough assets to pay back business debts, creditors can take the personal assets of the owner.
- Raising capital can be difficult since the owner is responsible for all the business funds, which can limit the size of the business
- The business may end with the owner’s death, unless if it is transferred to the heirs, which creates a new sole proprietorship
- Owner must pay personal income taxes on the profits of the business
GENERAL PARTNERSHIPS
General partnerships are owned and operated by two or more individuals. All partners manage the business and assume responsibility for its debts.
Advantages
- Easy to start and set up as there are no complex documentations needed
- Low set up costs
- Flexible structure that can respond to partners’ situation and needs
- Net business losses can be deducted from your personal taxes
- You share the responsibility of raising capital with the other partners
Disadvantages
- The owners are personally liable for all the debts and liabilities incurred by the business. If the business does not have enough assets to pay back business debts, creditors can take the personal assets of the partners.
- Owners must pay personal income taxes on the profits of the business
- Power struggles between the partners may lead to the failure of the business
- A partner cannot sell his/her stake in the business without the consent of the other partners.
- The exit of one of the partners may lead to the dissolution of the business
LIMITED PARTNERSHIPS
A limited partnership consists of two types of partners: General partners and Limited partners. The general partners own, operate, and assume liability for the business. The limited partners only act as investors for the business, they don’t have control over the business.
Advantages
- It’s relatively easy to get investors because limited partners have limited liability to the business debts.
- General partners can get the money they need to operate from the limited partners, and still maintain control over business operations
- Limited partners get to share in the profits of the business without having to operate the business
- The limited partners are liable for only the amount of capital they contributed to the business. It’s not possible for business creditors to go after the personal assets of the limited partner.
- The limited partners can exit anytime without dissolving the business partnership
- Profits and losses pass through the business to the partners, who are taxed on their own personal income tax returns.
Disadvantages
- The general partners are personally liable for all the debts and liabilities incurred by the business. If the business does not have enough assets to pay back business debts, creditors can take the personal assets of the partners.
- There are state filing fees which needs to be paid as a certificate of Limited Partnership must be filed with the state before the partnership comes into existence.
- It’s mainly suited to businesses such as real estate investment groups or in the film industry
CORPORATIONS/PRIVATE LIMITED COMPANY
Corporations/Private Limited companies are completely independent legal entities that exist separately from the company’s owners. This is the most common structure of businesses.
Advantages
- Owners are not liable to the debts and liabilities of the company
- There are many tax-free benefits, such as insurance, travel, and retirement plan deductions
- Easy transfer of ownership through selling of stock
- Change of ownership may not affect the management and the business operations
- Easier to raise capital as many investors/shareholders can contribute
Disadvantages
- There are state filing fees which needs to be paid as Articles of Incorporation must be filed with the state before the company comes into existence.
- Complex documentation needed to start the business.
- Corporates are subject to various rules and reporting requirements which they must comply with e.g. tax, accounting and legal issues.
- There is double taxation of profits. The corporation pays corporate tax on its profits, and the shareholders also pay tax on the dividends.
- Dilution of shares as more investors get into the business may cause the founder to loose control of the business
These are the 4 common types of business structures across the globe. There are other structures which are unique to certain countries and certain states. If you are still unsure of the right structure for your business, then you may have to consult your lawyer and your accountant.
We wish you the best in your business!Check out our collection of business plans , and more business ideas.
