5 Common Types of Business Structures for Your Company
Updated September 30, 2022
Illustration of three types of businesses in a row.
When you start a company, one of the first steps is to choose the type and structure of your business. Regardless of the business domain that your organization operates in, the business type has a direct impact on its long-term success. Choosing the right type of business is an essential step, but it requires knowledge regarding the different types as well as an estimate of the size and structure of your business.
In this article, we discuss common types of businesses and structures to help you choose the best option for your company.
Types of businesses
Before you decide what type of business organization to choose, assess your company to determine its general business type. Depending on what you sell, there are typically three different types of businesses:
These businesses do not sell tangible products. Instead, they offer their professional expertise in various matters, such as providing advice and performing specialized tasks for their customers. For example, schools, law firms and nail salons are all service businesses.
Merchandising businesses purchase large quantities of products at reduced prices and sell them individually at retail prices without changing their initial form. These companies make a profit if the amount of money they receive from reselling purchased products exceeds the purchase price and business operating costs. Some examples of merchandising businesses are grocery stores and clothing stores.
These businesses purchase various raw products and then manipulate them to create a new product to sell. The process involves combining raw materials, technology, human labor and overhead costs to create a manufactured good that can be sold to customers. If the price of the sold manufactured goods exceeds the combined costs of production, the company turns a profit. For example, automotive companies and bakeries are both manufacturing businesses.
Types of business structures
Once you have established what kind of business you plan to run, you can choose the business structure that works best for your goals. The way you structure your business depends on whether you are acting alone or with partners, how much personal liability you are willing to accept and whether you will issue shares to investors to get your business started.
Major types of business structure include:
1. Sole proprietorship
A sole proprietorship is a type of business where there is no legal distinction between the business entity and its owner so it best fits situations where the organization only has one owner. It is a popular choice for small businesses due to the low initial costs. Also, any generated income is only taxed once instead of being taxed as a company and then again as a personal source of income. They are also subjected to less taxation and regulation compared to other types of businesses.
However, if your business is a sole proprietorship, there is no distinction between your assets and those that belong to your company, which may be an issue if your company experiences financial challenges.
A partnership is a formal agreement between two or more individuals to run a business together. It can also be established between two or more businesses or between businesses and individuals. The partnership agreement clearly states the amount of authority, potential profits and liabilities that each partner is due. Although the partners share benefits and responsibilities, one partner's choices can potentially affect the entire company.
There are three types of partnerships—general, limited and limited liability partnership (LLP). In a general partnership, all partners assume liability for the company's potential losses, debt and other obligations. In a limited partnership, some of the partners are solely investors who have no managerial control or liability. LLPs are similar to general partnerships, where multiple partners are each responsible for the operations of the business. However, partners in LLPs are not personally responsible for the actions of other partners or the debts of the business. This type of business is often restricted to certain professions, such as lawyers or accountants.
Related: FAQ: What Are Partnerships?
Corporations are companies that have been authorized to act as single entities. When a company's owner incorporates their business, they essentially separate their personal liability from that of the company. Corporations have many of the rights and responsibilities that individuals enjoy, such as owning assets, hiring employees and paying taxes. However, they are subject to state regulation, with a state-imposed board structure and taxation of both business and personal revenue.
Owning a corporation is typically more flexible than other types of business, as you can transfer it in the form of stock. However, the high number of rules and regulations that a corporation must follow typically means you may have to pay higher costs for accountants and attorneys compared to other types of businesses.
There are three kinds of corporations:
C corporations: These corporations are taxed as business entities, and the owners' received profits are then taxed again individually.
Benefit corporations: These corporations, sometimes called a B corp, are for-profit corporations recognized by a majority of U.S. states. B corps are different from C corps in purpose, accountability, and transparency but are taxed the same.
Close corporations: These resemble B corps but have a less traditional corporate structure. State rules vary, but shares are usually barred from public trading. Close corporations can be run by a small group of shareholders without a board of directors.
S corporations: Deriving from “small business corporation,” this type of business organization divides income and losses among its shareholders. This means that the corporation itself does not pay any income taxes, making it an effective way of avoiding double taxation.
Nonprofit corporations: These corporations are exempt from all taxes, but they must operate without generating a profit. A nonprofit corporation can achieve this if it invests all of its generated cash flow for expansion and future operations. This is a type of business organization that's most often used by charitable entities.
4. Limited liability company
As with corporations, limited liability companies (LLCs) separate the owners' liability from that of the company. They can be taxed either as corporations or as partnerships, and they can be owned by many different types of business entities, such as trusts, corporations, individuals and other LLCs.
Although similar in structure to S corporations, LLCs do not put their shareholders' personal belongings at risk, separating the personal liabilities from the ones that the company generates. Also, as opposed to S corporations, there are fewer rules and regulations for the company to follow, which reduces the time and money spent with accountants and attorneys.
A cooperative is a business that is operated solely for the benefit of those who own it and use its services. This implies that the business distributes its generated earnings to its members, also called user-owners. The company's members typically vote to elect a board of directors to make any necessary managerial decisions.
Why is it important to know the types of businesses?
Choosing the type of legal structure your company will operate under is one of the most important decisions for an entrepreneur. Knowing what your options are when it comes to business type and structure can be crucial for your company's future success. No business structure is inherently better than another, however, with each one being appropriate in different situations for particular business objectives.
Here are some reasons why it's important to understand the different types of businesses you can choose from:
The cost of setting up a company can become a challenge early on, so it's important to be prepared. Choosing a business type that can accommodate both your initial budget and future growth objectives is essential when setting your business up for success.
Risk limitation and asset protection
If limiting risk and liability is an important factor for you, knowing the types of businesses that minimize exposure can be crucial for protecting your assets.
A company's taxation level and structure can vary depending on your chosen business type. Knowing the available types of businesses allows you to choose the one that works best for your company and yourself.
Some business types have additional legal and reporting obligations that may require your time and money, so it's important to familiarize yourself with your options and their specific requirements.
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