When making a checklist for your small business, the structure is probably the last thing that comes to mind. However, one of the most vital decisions you can make is the legal form the business would take. This decision can save you a lot of time, resources, and assets in the future. If you have been conflicted about the business structure to go for, keep reading as we delve into the various forms available.
For a small business, there are three main options: sole proprietorship, partnership, and a limited liability company. Note that your decision has far-reaching effects on the taxes you will pay, the risk level, and the safety of your personal assets.
1. Sole Proprietorship
As the name implies, a sole proprietorship is an unincorporated company owned by one person. This is the most common business structure in the United States. It makes up around 70% of existing small businesses today. Due to its unincorporated nature, the owner and the company are the same. Sole proprietorships do not establish a distinct legal entity. This means all business benefits, responsibilities, liabilities, and assets accrue to the owner.
Pros
- A sole proprietorship gives the owner full control of the business. It is important to achieve your personal goals for the small business.
- Fast decision-making. There is no board of directors to consult and administrative hurdles to cross.
- No company income tax. All income is considered for the owner and taxed at their income tax rate.
- Few legal requirements and paperwork.
Cons
- The owner bears the risk of business failure alone. Personal assets and funds can offset a debt owed to creditors.
- Difficulty raising capital. Most banks and financial institutions need to be convinced of the credibility of small unincorporated businesses and might not be willing to approve loans.
- The pass-through-taxation system can weigh too much on your finance.
2. Partnership
A partnership is a business established when two or more people pool resources together to make a profit. There is usually a legal agreement highlighting the aims and objectives of the partnership and the powers, responsibilities, and stakes of each partner. This business structure works best if your business requires multifaceted expertise, as each partner can contribute according to their strength. It is also perfect if you find sole proprietorship too cumbersome. There are two types of partnerships:
- General Partnership: All members are involved in the business’s day-to-day activities. The partners are company managers liable for debts according to their stake in the business.
- Limited Partnership: General partners are responsible for the daily operations, while passive partners are mere investors who do not take on administrative duties. Unlike general partners, passive partners are not personally liable for debts incurred.
Pros
- Liability and responsibilities are shared among the partners, unlike in a sole proprietorship.
- The death or exit of a partner does not terminate the company.
- Operates a pass-through-taxation system where only the personal income of partners is taxed.
Cons
- General partners in a limited partnership are personally liable for debts incurred.
- Requires more paperwork and legal services.
- Slow decision-making process.
Limited Liability Company
This is an incorporated company registered under the law as an independent, distinct legal entity. The owners are called members, and they have shares in the company. Unlike sole proprietorship and partnership, there is no incidence of personal liability as all benefits and liabilities are borne by the LLC. This is ideal for businesses that have a good amount of risk involved.
Pros
- Raising loan capital is easier as LLCs enjoy more credibility and financial institutions are more eager to lend.
- The personal assets of members are well shielded from creditors or legal action.
- Tax incentives are granted to Limited companies in many cases.
Cons
- Relatively more expensive to form. Registrations and documentations come with various filing fees.
- It usually requires rigorous accounting requirements for filing tax returns and bookkeeping.
- It features cumbersome administrative activities, slow decision-making, and a higher level of accountability.