Common Types of Businesses and How to Choose the Right One for You
If you’re thinking about starting a business or are already in the process of doing so, you understand the amount of work that goes into becoming an entrepreneur. Whether you’ve just come up with a business idea or have already developed a plan of action, the first step is to create a business website. After that, you’ll need to dig into the legal aspects of business management and determine what type of business entity you want to be.
Understanding the different types of businesses and business structures is an imperative part of the process, regardless of wether you are selling B2C or B2B, and can help you set your new venture up for success.
Here are the types of businesses - and how to choose the right one for you.
Types of businesses
Which type of business you choose to establish has an influence on all of your business operations, from personal liability, to taxes and accounting.
The 5 primary types of businesses include:
The most common types of businesses
From SMBs to corporations, to parent company's, here is a detailed overview of everything you need to know to determine which type of business is best suited for you.
Sole proprietorships are the simplest, easiest and cheapest type of business to create, typically costing between $10 and $100 to establish. While they do not have to register a business with your state, local registration is typically required and a business license or permit may be necessary depending on your industry. Make sure to check with your municipality to determine exactly what is necessary to establish yourself as a sole proprietor.
Liability is a key consideration. Sole proprietorships have unlimited liability, meaning they are solely responsible for all business activity, including debt. Even if the owner creates a business plan and gives their business a separate name from their own, they do not establish a new legal business entity: the business owner and the business are one and the same.
This makes filing taxes much simpler than for other types of businesses. Sole proprietorships are considered pass-through entities, also known as flow-through entities, meaning that profits are “passed through” to business owners and claimed on their personal tax returns.
For example, let’s say Hank is a master landscaper and wants to establish himself as a landscaping business called Hank’s Landscaping. If he registers his business as a sole proprietorship, his personal and business assets are linked, and all liability of Hank’s Landscaping falls onto Hank.
Creating a sole proprietorship is a great way for business owners to start out, and they may choose to expand to a corporation or LLC as their business grows.
As the name implies, a partnership allows for two or more people to start a business together and is the simplest business structure for doing so. Partnerships allow owners to have equal stake and to share liabilities, and they may or may not need to register with their state, depending on where they live.
The two most common types of partnerships are:
General partnerships (GP)
Limited partnerships (LP)
GPs imply that all business partners have equal authority within the business, meaning any partner can make legal decisions and contribute to daily operations. Typically, profits and losses are also split equally.
LPs imply that partners do not have equal say in the business. In this scenario, the main partner manages the business and has a say in daily operations, while the limited partner, also known as “the silent partner,” does not.
Like sole proprietorships, partnerships are pass-through entities - all partners need to claim company profits on their personal tax returns.
This is a common business structure you are probably familiar with. But did you know there are actually 5 primary types of corporations? These include:
C corps, unlike sole proprietorships and partnerships, are separate legal entities from their owners.
What does this mean exactly? It means that owners have limited liability and their personal assets are not at risk if the company fails or is sued. This also implies that business owners are not personally liable for company debt.
In the US, owners of C corps must legally incorporate their businesses in their state, which allows shareholders to hold stock in the company. Shareholders then elect a board of directors who are responsible for guiding business decisions.
Unlike other types of businesses, C corps are the only business structure subject to corporate income tax, meaning the company must pay tax on profits. This subjects C corps to double taxation, making them a better choice for larger companies. Corporate income tax is first paid on income, and then both stockholder distributions and shareholder income are taxed on shareholders’ personal tax returns.
S corps have certain limitations and are ideal for smaller corporations that are just starting out. Their limitations include:
They can only have up to 100 shareholders.
They can only have one class of stock.
One of the key factors that distinguishes S corps from C corps is tax structure. Like sole proprietorships and partnerships, S corps are considered pass-through entities, providing the business owner with unlimited liability.
The B stands for “beneficial,” and these types of businesses consider the “triple bottom line” in their day-to-day operations: profit, people, planet.
However, B corps do not have unique tax structures - they can register as either C Corps or S Corps.
To be considered a B corp, the company must demonstrate a commitment to social and environmental sustainability, public transparency and legal accountability. They also need to be certified by B Lab, a nonprofit organization that promotes social and environmental justice through business.
These types of enterprises are smaller and act similarly to partnerships. Close corporations must register with the state they’re incorporated in, although not all states recognize these types of businesses.
Better suited for smaller companies, this business structure allows for some of the benefits of corporations but have certain limitations, like S corps. Limitations include:
Stakeholders are capped between 30-35, depending on the state.
Stocks cannot be made public.
Close corporations must also have a written shareholder agreement, a document outlining the relationship between the corporation and its shareholders. This is not required of other types of corporations, and it makes close corporations more expensive to establish. However, the close corporation status allows for fewer formalities and gives shareholders a say in who can and can’t buy stocks.
Tax structure is the same as C corps, making close corporations liable to double taxation.
Also known as co-ops, this is a type of corporation that is particularly unique because of its ownership structure. This type of business is managed and operated by those that use the product or service the business produces.
As opposed to a board of directors, co-ops promote economic equality and are managed equally by everyone who has ownership, despite how much they invested. This also means that profits are distributed equally amongst all members.
Nonprofits are technically considered corporations because they are required to file articles of incorporation with the state they're registering in. However, they are unique business structures because they are considered non-business entities because their purpose is not to earn profit. Nonprofits are dedicated to serving a particular charitable mission or cause and are exempt from paying federal income taxes by claiming 501(c) status with the IRS.
The two main types of nonprofits are public charities and foundations. But what’s the difference between the two?
Public charities receive donations for funding a specific mission directly. Donations can come from individuals or grants from either foundations or the government. Foundations are typically established with a sum of money from a single source, such as a family. They provide grants to public charities that serve a purpose in line with their goals.
While nonprofits do have boards of directors, they do not have shareholders and any profit raised goes directly back into the corporation to serve its mission.
Limited liability company (LLC)
LLC organizations combine features of corporations with those of sole proprietorships and partnerships. While laws pertaining to LLCs vary by state, their basic structure is the same across the board.
Like C corps, owners of LLCs have limited liability. But they are also pass-through entities like partnerships, making LLCs a less formal business structure than corporations.
How to determine which business structure is right for you
You'll want to consider these factors:
Cost and complexity of establishing your business
Partners or investors
Local and state laws
The type of business you establish will have significant implications on how much tax you pay. For example, if you choose to establish a C corp, you will be protected from personal liability, but subject to double taxation.
And as pass-through entities, sole proprietorships, partnerships, S corps and LLCs grant you the benefit of claiming profits on your personal income taxes.
You should also keep in mind that tax laws can vary based on your state or locality. For complete, updated information about the tax implications of your business structure, you should refer to the IRS website.
Determining the level of liability you will need depends on your type of business, what you are selling, and what your operating budget is. For instance, if your business is high risk, establishing yourself as a corporation or LLC might be worthwhile to protect your personal assets. A business is considered high risk if it's in a heavily saturated market or there is a high risk for financial failure.
Cost and complexity of establishing your business
Different types of businesses require various establishing procedures as well as costs for doing so. For example, corporations and LLCs must register with their state. Sole proprietorships, however, do not and can register at the local level quickly and easily for a nominal fee.
Partners, investors and loans
If you have business partners or investors, or plan to in the future, take this into consideration because not all types of businesses allow for them. While you can certainly change your business structure as you grow, this should be a factor in your initial decision-making.
Additionally, some banks and business lenders may choose not to issue loans to sole proprietorships or partnerships. If you need to raise money for your business, such as by taking out a loan, you need to consider this point.
Local and state laws
Local and state business laws vary. Understanding what is legally allowed in your city and state - and balancing that with your business structure - is key.
For example, only certain states require partnerships to register, but all states require corporations to do so. It's also important to note that not all states recognize certain business structures, such as close corporations.
Once you have considered all there is to know about the different types of businesses, you can make an informed decision as to which business structure to establish for your new venture.
By Talia Cohen