Selecting an Ownership Structure for Your Small Business

One of the most important decisions you will make about your company involves its ownership structure. When you choose the type of small business you want to run, it will have an effect on firm's liability, financial situation, and the taxes you complete with your small business finance software.

What types of ownership structures are possible?

The most popular options chosen by entrepreneurs are sole proprietorship, partnership, limited liability company, S Corporation, and C Corporation.

Just because you choose one type of ownership structure in the beginning doesn't mean you can't change as your business matures and grows. Keep weighing the benefits and drawbacks of each path to ensure your structure is right for your company.

What questions should I consider?

First, think about what type of business you want to run and how much control you would like to have.

Sole proprietorship

This ownership structure is the most common form of small business, in which an individual is fully and legally in charge of their company. These are owned by a single individual who runs the firm on a day-to-day basis and owns all of its assets and profits.

When you have a sole proprietorship, you report business income and losses using small business finance software and claim it on your personal tax return. You are also liable for business debts and any claims made against your company.

Benefits. This is the most simple and straightforward form of ownership, with the least red tape. Entrepreneurs who want complete decision-making control over their company may be attracted to sole proprietorship. With this route, profits flow directly to your personal tax return and you can use business revenue as you wish.

Drawbacks. Legal liability is the largest disadvantage to sole proprietorship. If you go into debt or someone sues your company, both your business and personal assets are vulnerable. In comparison to other ownership structures, you may also be at a disadvantage when it comes to raising funds or attracting employees that would like to become partial owners one day.

Business partnership

A business partnership is similar to a sole proprietorship, except two or more people are involved and each owner's responsibilities are defined by a partnership agreement. Each owner pays taxes on their proportion of the business income, claiming it on their personal tax returns. They also share liability for business debts and court judgments.

Benefits. You may enjoy the opportunity to share the entrepreneurial experience with someone else. You can also pool resources, knowledge and may improve your chances of raising needed funds. Additionally, business profits flow directly to the owners.

Drawbacks. A partnership has the same legal liability risk as a sole proprietorship. At the same time, some entrepreneurs may not be suited to making joint decisions and sharing profits with another owner.

Limited liability company

A limited liability company (LLC) offers protection for owners— who are called "members"—from personal liability for business debts. It also provides the same type of pass-through income tax advantages of a partnership.

Benefits. Some say that limited liability companies combine the best features of corporations and partnerships. For one thing, you are not liable for business debts or claims made on your business. Secondly, unlike with a corporation, an LLC's profits and losses flow through the company directly to the individual members. Business owners who set up LLCs instead of a corporation also find there is less red tape and more flexibility regarding how the company is managed.

Drawbacks. An LLC is more complex to set up than a sole proprietorship or partnership. Additionally, some angel investors and venture capitalists may be less likely to offer funding to an LLC than to a corporation.

Corporation

A corporation is an independent legal entity that is taxed, able to be sued, and liable for debts. The company itself is taxed on profits and losses, rather than the owners. Instead, the owners—known as "shareholders"—claim income received from salaries, bonuses, or dividends on their personal tax returns. Changing the ownership of a corporation does not dissolve it.

Benefits. Shareholders have limited liability if the company is sued or falls into debt (however, there are some exceptions in which the owners could be held responsible, such as failure to pay taxes). Corporations are also able to raise funds by selling stock, as well as deducting the cost of many employee benefits. One more benefit involves the potential to qualify for S corporation status, which has tax benefits.

Drawbacks. Setting up a corporation is more involved than creating a sole proprietorship or LLC. It has a complex structure and reports to a board of directors and shareholders. Corporations may need to complete a large volume of paperwork than businesses under other forms of ownership. Finally, there is the issue of double taxation—in addition to paying corporate income taxes, dividends to shareholders are taxed again.