The 4 Major Business Organization Forms
Business organization is the single-most important choice you’ll make regarding your company. What form your business adopts will affect a multitude of factors, many of which will decide your company’s future. Aligning your goals to your business organization type is an important step, so understanding the pros and cons of each type is crucial.
Your company’s form will affect:
- How you are taxed
- Your legal liability
- Costs of formation
- Operational costs
There are 4 main types of business organization: sole proprietorship, partnership, corporation, and Limited Liability Company, or LLC. Below, we give an explanation of each of these and how they are used in the scope of business law.
The simplest and most common form of business ownership, sole proprietorship is a business owned and run by someone for their own benefit. The business’ existence is entirely dependent on the owner’s decisions, so when the owner dies, so does the business.
Advantages of sole proprietorship:
- All profits are subject to the owner
- There is very little regulation for proprietorships
- Owners have total flexibility when running the business
- Very few requirements for starting—often only a business license
- Owner is 100% liable for business debts
- Equity is limited to the owner’s personal resources
- Ownership of proprietorship is difficult to transfer
- No distinction between personal and business income
These come in two types: general and limited. In general partnerships, both owners invest their money, property, labor, etc. to the business and are both 100% liable for business debts. In other words, even if you invest a little into a general partnership, you are still potentially responsible for all its debt. General partnerships do not require a formal agreement—partnerships can be verbal or even implied between the two business owners.
Limited partnerships require a formal agreement between the partners. They must also file a certificate of partnership with the state. Limited partnerships allow partners to limit their own liability for business debts according to their portion of ownership or investment.
Advantages of partnerships:
- Shared resources provides more capital for the business
- Each partner shares the total profits of the company
- Similar flexibility and simple design of a proprietorship
- Inexpensive to establish a business partnership, formal or informal
- Each partner is 100% responsible for debts and losses
- Selling the business is difficult—requires finding new partner
- Partnership ends when any partner decides to end it
Corporations are, for tax purposes, separate entities and are considered a legal person. This means, among other things, that the profits generated by a corporation are taxed as the “personal income” of the company. Then, any income distributed to the shareholders as dividends or profits are taxed again as the personal income of the owners.
Advantages of a corporation:
- Limits liability of the owner to debts or losses
- Profits and losses belong to the corporation
- Can be transferred to new owners fairly easily
- Personal assets cannot be seized to pay for business debts
- Corporate operations are costly
- Establishing a corporation is costly
- Start a corporate business requires complex paperwork
- With some exceptions, corporate income is taxed twice
Limited Liability Company (LLC)
Similar to a limited partnership, an LLC provides owners with limited liability while providing some of the income advantages of a partnership. Essentially, the advantages of partnerships and corporations are combined in an LLC, mitigating some of the disadvantages of each.
Advantages of an LLC:
- Limits liability to the company owners for debts or losses
- The profits of the LLC are shared by the owners without double-taxation
- Ownership is limited by certain state laws
- Agreements must be comprehensive and complex
- Beginning an LLC has high costs due to legal and filing fees