July 7, 2022
When you start a business, you’ll be asked to choose between one of three main business entities—sole proprietorship, partnership, or corporation—each with its own pros and cons. You’ll also have the option of choosing an LLC (limited liability company) or LLP (limited liability partnership). If you decide to start your business as a sole proprietorship, you’ll have complete control over the business, but this will also make you responsible for any debts and liabilities that arise during its operation.
One benefit to a sole proprietorship is flexibility; you can operate your business under any name or form that you like. However, as a single owner, you are personally responsible for all debts and liabilities incurred by your business. This means that if something goes wrong with your business, such as a lawsuit or financial loss, it could jeopardize your personal assets (bank accounts, savings) as well. In other words: If your sole proprietorship fails and racks up debt in excess of its assets (such as an office lease), creditors may come after you personally to collect money owed. In contrast, if a corporation goes bankrupt, stockholders have limited liability because they're shielded from most debts by corporate law and their shares of ownership.
Partnerships are a popular way to start a business when you're working with friends or family. Partners have unlimited liability, meaning they're personally responsible for any debts and liabilities that aren't covered by insurance. On top of that, all partners must share ownership equally and can participate in making decisions. Because there's no legal separation between partners, you also don't have to worry about dissolving your partnership—it happens automatically upon the death or departure of a partner. If you want to keep control over your company but don't want to deal with registering your business as an LLC or S-Corp (or paying their associated fees), general partnerships could be a good option for you.
LLCs protect business owners by limiting their personal liability. If a company has LLC status, it can limit its own liability and that of its managers, members, and employees. The structure also has flow-through taxation which means all profits or losses are passed directly to owners’ individual tax returns. LLCs require less paperwork than corporations and have less formal organizational requirements; you don’t need to hold annual meetings for example (although you should keep good records). As a result, LLCs are faster to set up and less expensive than other options. There is an upper limit on how many members your LLC can have (100) but there’s no restriction on foreign ownership so long as your operating agreement allows it.
A corporation is a special type of business entity that can offer certain benefits to its owners. These include limited liability and perpetual life (for C corporations). However, there are also two other types of business entities—S corporations and LLCs—that provide many similar benefits. In general, a corporation will be taxed as a separate tax entity from its owners, while an S corporation and an LLC are both pass-through entities. In practice, however, corporate status isn’t always worth it; consulting with a tax advisor is your best bet if you have any questions about your particular situation. Even then, you’ll need to balance corporate taxes with income taxes in order to get an accurate picture of what type of business structure is right for you.
If you want to incorporate as a non-profit, your goal is typically to support a cause or social initiative rather than make a profit. There are several types of nonprofits, including charitable organizations and those that focus on furthering science or education. Nonprofits don’t pay income tax, but donations made to them are tax deductible. Though revenues can be used to benefit employees (for example, shared time off) they can’t be turned into profits paid out in bonuses, dividends or other forms of financial compensation. One small distinction that often goes unnoticed: For accounting purposes, you can still refer to yourself as non-profit even if your mission changes from being purely philanthropic in nature.
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