Business Form and Management of the Business: Pros and Cons

Starting a small business is an exciting venture. But, it comes with important decisions, like choosing the right business structure. This choice affects everything from how you file tax returns to how you manage your business. There are several key types of business structures: sole proprietorships, general and limited partnerships, C corporations, and limited liability companies (LLCs).

Understanding these business formations can help lay the foundation for your business’s success. This article will introduce key considerations when choosing your business structure. First, we discuss the general pros and cons of each business structure. Then, we compare the different business structures based on liability, expenses, taxes, funding, and other factors. 

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Pros and Cons of Common Business Formations

Below, we introduce the basics of each business structure and some of their pros and cons.  

Sole Proprietorship

In a sole proprietorship, the owner usually manages all aspects of the business. Legally, there’s no distinction between the business and its owner. They’re easy to set up, but there are some drawbacks.

General Partnership

In a general partnership, two or more partners work together to run a business. All partners have equal rights in the management of the partnership (subject to the partnership agreement). 

Limited Partnership

In a limited partnership, at least one general partner is responsible for the management of the business. Other partners are “limited,” meaning they do not participate in the management of the business. In exchange, they are mostly protected from personal liability.

Corporation

Corporations are run by directors and officers, but they are owned by shareholders. An elected board of directors manages the corporation’s business affairs. The officers execute the Board’s directives and run day-to-day operations. Shareholders receive reports regarding the financial status of the corporation and receive dividends without having to provide any labor or input.

Limited Liability Companies (LLCs)

LLCs are popular business entities because they offer flexibility. They provide the liability protection of a corporation and the independent management you’d see in a partnership or sole proprietorship. The members of a limited liability company either manage the business affairs of the company themselves or appoint a manager to operate the business.

Liability and Risk

One of the most crucial aspects to consider when choosing a business entity is the type of business liability you will incur as a business owner. How much personal risk are you willing to take? The general rule is that the more dangerous or risky the activity that your business will engage in, the less personal liability you will have. Here is how the different business structure types differ on liability:

• Sole Proprietorships: The sole proprietor’s personal assets are at risk if the business faces legal issues.
• Partnerships: In a general partnership, partners share liability. Limited partnerships protect limited partners from personal liability.
• C Corporations: In a C corp, there is liability protection. Shareholders are not personally liable for business debts.
• LLCs: Members enjoy liability protection like a C corporation. They also allow flexibility in management.

Liability considerations are vital to protect your personal assets. Choosing a structure with the right level of liability protection can safeguard your personal finances from business-related risks. Small-business owners should consider liability when choosing their business structure.

Expenses and Procedures

Starting a business involves various expenses and procedures. These can differ greatly among business entities. Let’s take a closer look at the expenses and procedures of different types of business structures.

• Sole Proprietorships: These businesses have low startup costs and simple procedures. They are the simplest business entity to start up. These often require a DBA (doing business as) business name registration with the secretary of state’s office. You might also need a business license (depending on your industry).
• Partnerships: These businesses may need a partnership agreement. They are generally simple to set up, like a sole proprietorship. There are rarely any fees associated with establishing or maintaining a sole proprietorship or partnership.
• C Corporations: These businesses incur higher startup costs due to legal and administrative fees. You must file the articles of incorporation with the secretary of state and pay fees associated with incorporation. The details of the articles of incorporation and the amount of the fees will vary depending upon the state where you set up your business.
• LLCs: These businesses have a moderate startup cost. They might also need an operating agreement.

The costs and complexity of starting a business can influence your choice. While some structures are inexpensive and easy to start, others need more investment in time and money.

Income Taxes

Taxation is a significant factor in choosing a business structure. Each type has different implications for filing taxes and tax rates. Here is how the different business structures vary on income tax structure:

• Sole Proprietorships: These businesses report business income on personal tax returns. They are subject to self-employment taxes.
• Partnerships: These businesses report business income on personal tax returns. They are also subject to self-employment taxes.
• C Corporations: A corporation is a separate tax entity. So, it must pay taxes on any profits that remain within the company during a tax year. It also has to pay taxes on any profits paid out as dividends to shareholders. These businesses face double taxation on profits and distributions. There is a tax benefit to forming your business as a corporation. The owners of a corporation do not pay taxes on any profits that the corporation keeps. The corporation pays taxes at a lower rate than some individuals.
• LLCs: These businesses can choose how they are taxed and avoid double taxation.

Sole proprietorships, partnerships, and LLCs often are "pass-through" tax entities. This is because the business taxes on profits and losses pass through to the business owners on their personal income taxes. These business owners must report and pay taxes on all net profits. They must do this even if they take no money from the business’s account during the tax year.

The owners of a corporation do not pay taxes on the net business profits of the corporation. Instead, the business owners of a corporation pay taxes only on the profits they take from the corporation. This is in the form of salaries, dividends, and bonuses.

Selecting a structure that aligns with your financial goals and simplifies the tax process is crucial. The right choice can optimize your tax situation and reduce unnecessary costs and burdens.

Growth and Funding

The ability to attract investments is crucial for growth. Each business structure offers different opportunities and challenges for raising capital.

• Sole Proprietorships: These businesses are limited to personal funds and small business loans.
• Partnerships: These businesses rely on contributions from general partners and limited partners.
• C Corporations: These businesses can raise capital through the sale of stock. Because of this investment scheme, it may allow owners of a corporation to attract investors. They can also keep employees by offering stock.
• LLCs: These businesses have flexible investment options. But, they are generally less attractive to investors than C corporations.

Your choice should align with your funding needs and growth plans. Some structures are better suited for attracting large investments. Others offer more modest funding avenues.

Management and Ownership

Who controls the business and how it is managed are fundamental aspects of your business entity decision. This is how the different types of business structures vary in management and ownership:

• Sole Proprietorships: The owner (sole proprietor) has complete control.
• Partnerships: General partners manage these businesses. Limited partners typically don’t have a say because they only contribute capital.
• C Corporations: A board of directors manages these businesses. Owners are shareholders.
• LLCs: The business or elected managers manage these businesses.

Management style can influence your business’s daily operations and long-term strategy. Choose a structure that aligns with how you want to manage your business.

Flexibility and Adaptability

In a changing market, the ability of your business structure to adapt can be a significant advantage. Here is how the different business structures vary in flexibility and adaptability:

• Sole Proprietorships: These structures are highly flexible and easy to change direction.
• Partnerships: These structures depend on the flexibility of the partnership agreement.
• C Corporations: These structures are less flexible due to regulatory requirements.
• LLCs: These structures combine the flexibility of a small business with the benefits of a legal entity.

Your business’s ability to adapt to new opportunities and challenges can make a big difference. Consider a structure that allows the flexibility your business might need.

Industry and Professional Requirements

Different industries and professions have unique requirements that may influence your choice of business structure.

• Sole Proprietorships: These business structures are ideal for low-risk industries.
• Partnerships: These business types are suitable for professional groups.
• C Corporations: Businesses planning to go public prefer these business structures.
• LLCs: These business types are versatile for various industries, especially those that need liability protection.

Understanding the norms and requirements of your industry can guide you in choosing the most suitable business structure.

Exit Strategy

Every business owner should consider their long-term plans. This includes how they might exit the business when the time comes:

• Sole Proprietorships: These businesses are easy to dissolve but offer no continuity.
• Partnerships: These businesses depend on the partnership agreement terms.
• C Corporations: These corporations can be sold or transferred to others.
• LLCs: These businesses have flexible exit strategies and are like C corporations in this way.

Your exit strategy should align with your personal and business goals. Consider how each structure can accommodate your plans for transitioning or closing your business.

Form Your New Business

Whether you’re starting your new business, would like to transition to a different legal structure, or have other questions about your business, you may benefit from using a DIY service or getting legal help. We offer access to both! Try our DIY formation services for an easy, step-by-step process to form your business today.

Prefer to work with a lawyer? Contact a local business organization attorney who can help ensure that your business is structured for success.