As you plan to start a business, one among the many decisions you have to make during your beginning stages is deciding the type of business entity you want to build. This decision will have an all-round impact on the enterprise you want to build.
Your ownership type or style will determine your business’ structure. Each of the different types of ownership has its own pros and cons and it’s important to understand them before settling.
As you register your small business, you are legally required to state your business ownership. This helps define some legal configuration that outlines each participant’s rights to the business, control to the business, personal liability and the business’ financial structure. The type of ownership determines other important aspects such as your business’ tax returns.
Don’t choose a type just because you need one. Put into consideration the vision you have for your business, the level of control you want to have and the structure you are willing to deal with. Additionally, think of the profits you want to make, the tax implications of the different types, and each structure’s susceptibility to lawsuits.
This is the most common type of business ownership and most small businesses start out as sole proprietorship. In sole proprietorship, the business is owned by one individual who oversees the business’ day to day operations.
Starting your small business as a sole proprietor means you are the only one responsible for everything associated with your business – this is the good and the bad.
You make all the decisions in your business. You are the sole owner of your business’ assets and profits.
Additionally, you are responsible for all your business’ unlimited liabilities, debts and lawsuits. These unlimited liabilities, your business debts, your personal debts and lawsuits can be the end of your small business.
With sole proprietorship, you will deal with resource limitation such as limited sources of funding and limited skills. With limited skills, you end up being the jack of all trades; the business manager, marketer, the accountant, the social media manager and sometimes the delivery guy.
Sole proprietors are seen as one with their businesses. There is no separation between you and your business before the law and the public.
Benefits of sole proprietorship
- It’s the easiest and the cheapest form of ownership to establish.
- As a sole proprietor, you have all the power and can make whatever decision you see fit.
- You retain all the income the business makes and whatever earnings come from the business’ investments.
- You can easily dissolve the business at any given time.
Other Disadvantages of sole proprietorship
Sole proprietorship comes with unlimited liabilities.
- Might have a difficult time raising funds and will often be forced to tap into your personal finances to salvage your business.
- It might be difficult to recruit highly qualified employees for your business.
- You might not be able to give your employees some perks/benefits.
In partnership, the business is owned by two or more people. Before the law, these people are one with the business. They are responsible for everything associated with the business.
The law recommends a legal agreement that shows how things are to be done. This includes how decisions are to be made, how income and profits are to be shared, and how clashes are to be solved. Additionally, this agreements covers how partners can opt out, how they can be bought out, how new partners can be admitted and what steps will be taken to dissolve the partnership if need be.
The partners should also come up with guidelines on how they share time and capital – how much capital each contributes to the business and time each spends at the business.
Benefits of partnership
- Establishing a partnership is pretty simple. However, the partners should prioritize establishing a partnership agreement that binds them.
- Rising funds for the business is much easier as there are more owners compared to going solo.
- It’s easier to attract new partners especially from your employee team – employees with an interest of being partners.
- Different skills are a boost to benefit the business. One partner can be in charge of accounting, the other one marketing depending on their strengths, etc. It’s advisable to get into partnership with people whose skills are complimentary.
Disadvantages of partnership
- All the partners are jointly yet individually liable for each other’s actions related to the business.
- Income and profits must be shared equally among all partners.
- Partnerships are susceptible to disagreements and these differences can be the death of the business.
- Partnerships have a limited lifespan. Their lifespan can be tied to the death of a partner or withdrawal of a partner.
There are different types of partnership you could consider; general partnership, limited partnership, partnership with limited liability and joint venture.
Partners divide management responsibilities, liabilities, profits and losses as per their partnership agreement.
Limited Liability partnership
In this partnership the different partners have limited liabilities in line with their levels of investment into the business. This limitation influences the power of the partners and their involvement in decision making processes for the business.
Limited liability partnership is not common in the retail businesses and service based businesses. It majorly applies when the business is in partnership with short-term investors.
In joint venture the different partners come together for a specific period of time. Joint ventures are mainly for one-time projects. However, in-case these partners partner again in a following project, they will be recognized as ongoing partners/partnerships and are required to register as such. Whatever assets are acquired during the partnership are distributed after the project has ended or whatever entity was built has been dissolved.
A corporation business is one owned by individuals, shareholders and stockholders. It can be owned by a single shareholder or by several shareholders. The shareholder(s) elect a board of directors who then oversee the business’ operations and make decisions for the business.
The corporation is recognized by the law as a single entity separate from its owners. Even with the shareholders overseeing the business operations, the shareholders as individuals are not liable for the business’ actions and finances.
Types of corporation
There are different types of corporation
This is the most common type of corporation. The business owners get profits and are taxed as individuals. The business entity on the other hand is taxed as an organization.
An S corporation is formed just like a C corporation. However, it varies in terms of owner restrictions and tax implications. An S corporation can have up to 100 members (shareholders) and is not taxed separately; instead, the profits and losses are borne by the shareholders on their individual tax returns.
Non-profit corporations work towards a specific social cause and function under charitable organizations. These corporations are commonly used by charitable, religious and educational organizations to operate without making profits.
Non-profit corporations are exempted from taxation. Any revenue, donations and contributions received are retained by the organization.
Benefit corporations (B Corps) operate just like non-profit organizations. They have a mission but they are for-profit. The shareholders want to benefit the public as well as make profit. They come together to generate revenues and make returns according to their percentage of ownership.
Benefits of corporation
- Protection from personal liability such as lawsuits, debt and bankruptcy.
- Easier access to capital as they can easily borrow money from financial institutions.
- Unlimited life as the continuity of the corporation is not affected by death or withdrawal of shareholders.
- It’s easy to transfer shares ownership.
- Better management as the elected board oversees the working team (managers, employees, etc.)
Disadvantages of corporation
- Costlier incorporation costs
- More rigid protocols to be followed
- More time consuming
- Subject to double taxation
4.Limited Liability Company (LLC)
Businesses under LLC are private businesses and combine aspects of partnership and corporation. The business is owned by one or more individuals. These individuals are known as members or board members.
LLCs provide limited liability of a corporation and the flexibility of partnerships. However, in limited liability company ownership, the formation is more formal than that of general partnership.
In LLC, the board members’ personal assets are separated from business assets. Thus, just in case your business is hit by a lawsuit, your personal assets (personal car, house, land, etc.) are safe. The LLC members are not personally liable to the business’ debts and liabilities.
Limited Liability Companies are not tied to the same rigid regulations of corporations. Under such ownership, your business is protected and gives you the potential to scale. Additionally, under LLC you can easily create a tax plan that works for you because of the tax flexibility that comes with it.
Benefits of LLC
- Easy to set-up
- Member’s protection from liability
- Flexibility when it comes to tax. Easy to work with a tax plan
Disadvantages of LLC
- Higher startup cost – more capital
- Difficult to get outside capital
- Self-employment taxes
A cooperative is mainly formed for the benefit of the people who use its products and services. It is a private business owned by the same people who use its products and services. Its main aim is to benefit the people who operate it. The cooperative’s profit are divided among its employees known as user-owners.
The cooperative is however governed by an elected board, and members may purchase shares to participate in decision-making. Its employees are only taxed on their income.
The main disadvantage of a cooperative is the difficulty in receiving outside funding.
For any aspiring entrepreneur, deciding on the right business ownership is crucial and daunting.
Whatever entity you want to build, be sure to asses all possible options you have evaluating their advantages and drawbacks. Educate yourself as much as possible on the various options. If you need professional or legal help before making your final decision, do it.