Choosing the type of business structure you want to operate with is often one of the first (and most important) steps in starting a business. There are 4 main business structures: sole proprietorship, partnership, limited liability company (LLC), and corporations. The business structure you choose will have a significant effect on operations, taxes, and more.

Each type of business has benefits and drawbacks, and the best type depends on your unique situation. Here are the 4 types of businesses explained, with pros and cons to help you make a better decision.

Sole Proprietorship

A sole proprietorship has one owner, and the owner’s personal assets are not separated from the business. The business and the owner are one legal entity. Sometimes, local businesses or small e-commerce businesses will be operated as a sole proprietorship. If you decide to start a landscaping business and start taking clients tomorrow, you would be operating as a sole proprietor.

There are a few pros and cons to this type of business set up. Let’s go into these in a bit of detail.

Pros

1. Easy to Set Up. A sole proprietorship can be as simple as “just start selling”. They require virtually no set-up (beyond what you need to operate). Depending on your state, industry, and where you are selling, you may need to get a business license. If you’re just selling on a platform like eBay, some states don’t require you to get a business license. Check your state’s website for more information.
2. Full Control. As a sole proprietor, you make all of the decisions and bear the full financial risk and responsibility. It’s nice not having to answer to anyone or deal with conflict with partners. You have the ability to make the business completely unique to you and don’t have to compromise with anyone.
3. Easier Taxes. Business taxes are by no means easy, but sole proprietorship taxes are more simple than partnership or corporation taxes. Business income (minus deductions and credits) is taxed at the normal Federal tax rate (like any other job). Keep in mind, you do have to pay an additional self-employment tax on income (for Social Security and Medicare). For more information on self-employment tax, click here.
4. Flexibility and Adaptability. Since you are the only person making decisions, you have the ability to adjust any part of your business to meet changing customer demand quickly. You don’t have to negotiate with a partner or go through any bureaucratic process to enact change.

Cons

1. Unlimited Liability. This is one of the worst, if not the worst, drawbacks to operating as a sole proprietorship. Your personal and business assets are mixed, so you’re financially and legally responsible for anything that happens to the business. If you get sued or can’t pay a large business debt, your house, car, and any other personal asset you have is at risk of being taken to settle the debt.
2. Limited Resources. As a sole proprietor, you have to do everything yourself or pay someone to do it for you. You’re limited by time, skills, and money. It can be overwhelming trying to solve so many problems yourself, and you often don’t have the resources to pay for additional services initially.
3. The Business Does Not Run Without You. If you’re sick, someone needs to run the business. You’re needed throughout every step (unless you have employees who can cover your job responsibilities for you).

Partnership

A partnership is similar to a sole proprietorship, but it has more than one owner, called a partner. Partners are both legally liable for any business debts/legal actions taken against the business. Their personal assets are tied to the business, just like a sole proprietorship. Partners have to fill out a Schedule K-1 every year, and their percentage of net business income is attributed to their individual tax return. Partners can unequally share percentages of profits (the percentages are based on an initial agreement during formation of the partnership).

Partnerships have some advantages over sole proprietorships, as well as some drawbacks.

Pros

1. Shared Responsibility and Expertise: Having a partner means you can divide up tasks and responsibilities, making day to day tasks less overwhelming than with a sole proprietorship. When you’re having a bad day, your partner may be able to pick up some slack. If both partners have different skills, they can each contribute their expertise to the business. One partner might enjoy a responsibility the other partner doesn’t like. Either way, you’re not alone.
2. Shared Financial Burden: Partnerships allow for shared financial obligations. They make it easier to invest more capital initially. You can scale faster, and you are splitting any risks you take with someone else.
3. Broader Network and Contacts: You both know people who could help you out. One person might know a graphic designer willing to help brand the business, and another might know an accountant. You both have resources to pool in the best interest of the business.
4. Different Skills. You both have different skill sets and experiences to draw from. Maybe one partner is good at book work and the other is good at negotiating. These different skills put you at an advantage against a sole proprietor. You can learn to leverage your strengths and minimize your weaknesses as partners, creating a more resilient business.

Cons

1. Unlimited Liability: Partnerships have unlimited liability like sole proprietorships. Each partner is joint and severally liable liable for the debts and obligations of the business. This means each partner is on the hook for the full total, their assets combined. If one partner has a net worth of $10,000 and the other $100,000 and a liability of $50,000, the 2nd partner could be on the hook for $40,000.
2. Decision-Making Conflicts: When you’re working with someone, you’re bound to get into disagreements. It can take awhile to come to a compromise, and a partnership can be slower at making decisions than a sole proprietor generally is. If conflict is not handled properly by one or both parties, in the worst case, it could end the business. Always have an agreed upon conflict resolution plan before you start operating as a partnership.
3. More Complicated Bookkeeping. Record keeping for tax purposes is incredibly complicated. You have to have a good system because there’s more than one of you making transactions. Everything has to be allocated to each partner on tax forms, so it’s really important to keep everything straight. If one partner habitually fails to record expenses, it’s an accounting nightmare trying to fix it. Operating as a sole proprietor makes it easier to keep track of all of the transactions and deductions.
4. Shared Risks and Liabilities: You’re ultimately responsible for your partner’s actions, good and bad. Partnerships require a lot of trust. Without any sort of legal separation of personal assets, you could lose everything due to a partner’s misconduct.

Limited Liability Company (LLC)

A Limited Liability Company is a business structure that allows some legal separation from the owner. The business is a separate legal entity, but it is the same taxable entity as the owner. They aren’t overly complicated and provide protection for your personal assets. They can have one or multiple owners.

LLC’s are my favorite business structure for small businesses. They have a lot of pro’s and very few cons. Here are some of the good and not-so-great things about LLC’s.

Pros

1. Provides the same level of benefits as a sole proprietorship. If you’re a single-member LLC, it’ll provide the same pros as a sole proprietorship would. If you’re a multi-member LLC, it’ll provide the same pros as a partnership would.
2. Protection of Personal Assets. An LLC is a separate legal entity as its owner(s). In the event your business gets sued, all of your personal assets are considered separate. You don’t have to worry about your house, car, or any other personal asset being at risk in the event of a lawsuit.
3. Easy Taxes. LLC’s by default follow the same tax structure as a sole proprietorship or partnership would. The income an LLC receives on your behalf goes straight to your personal tax return with individual tax rates.
4. Versatility. LLC’s can function like a sole proprietorship (or a partnership if you have more than one member) or more like a corporation. Multi-member LLC’s can even elect to be taxed as a corporation. You can operate similar business projects under the same LLC (you may need to register a trade name or a dba in this case, check with your state). You can do a whole lot with them. They’re extremely versatile.
5. Less Formalities: Compared to corporations, LLCs have fewer formal requirements. You don’t need a board of directors, shareholder meetings, or extensive record-keeping.

Cons

1. More Expensive and Complex: LLC’s are more expensive to form than partnerships or sole proprietorships. Typically, you have to pay a fee to register your LLC with the state. Each state has different rules and regulations LLC’s have to follow. Some states have ongoing operations requirements for LLC’s as well.
2. Ownership Restrictions: LLCs might have restrictions on ownership structure. Some states have regulations on who can be an owner or require a minimum number of members.
3. Potentially Less Investor Attraction: Compared to corporations, LLCs might have a more difficult time attracting investors or coming up with non debt-based funding.

Corporation

A corporation is a separate legal and taxable entity. It doesn’t have one “owner”. Corporations have multiple investors (shareholders) that own a portion (shares) of the company. They receive a portion of the equity and make profit by selling the stock at a higher price or through periodic payments based on performance (dividends).

Corporations are managed by a board of directors. They are paid by the corporation, and they essentially work for the shareholders.

If you’re just one or a few people, this business type won’t be relevant. You can always incorporate later if you really grow.

Pros

1. Limited Liability: Shareholders are technically the owners of a corporations, and their personal assets are separate from the company. They’re generally protected from the company’s debts and liabilities. The corporation is its own legal entity.
2. Access to Capital: Corporations can raise funds for projects by selling stock. They can issue more shares (within reason, issuing too many would lower the stock price). A good corporation would attract investors hoping to make a profit.
3. Tax Flexibility: Corporations have some tax benefits and deductions not available to another type of business. Sometimes you actually pay significantly less in taxes than you would using another business structure. (How do you think the major companies routinely get out of paying taxes?)

Cons

1. Complexity and Formalities: There are a lot of regulations to corporations, and they need a lot of structure. There’s lot of paperwork and bureaucracy. Meetings, extensive records, and other administrative and legal burdens make running a corporation difficult.
2. Double Taxation: Corporations are “double taxed”, once at the corporate level and again when distributing dividends to shareholders.
3. Higher Costs: Setup and maintenance of a corporation are usually expensive because of legal and filing fees, ongoing compliance costs, and hiring necessary professionals, such as lawyers and accountants.
4. Stricter Regulation and Oversight: Corporations face increased scrutiny from regulatory bodies and stakeholders, leading to more stringent compliance obligations. For example, publicly traded corporations have to follow GAAP (generally accepted accounting principles) regulations in their accounting records. It’s very strict due to misconduct that caused the Great Recession in 2008.
5. Complex Decision-Making: Decision-making can be complex and sometimes slower due to the involvement of a board of directors and the need for consensus on major issues.

Final Thoughts

You’re the only person that knows what business structure is best for your business. Here are some tips to help you decide on the best type of business for you:

• If you’re going into business with one or two other people, an LLC is always a safe option. It protects both of you personally in the event of the business failing.
• You might want to consider an LLC if you’re on your own as well. It’s not always necessary, but people sue for ridiculous reasons and when you least expect it. Better safe than sorry, in my opinion.
• Make sure you research any licenses you will need for the industry you want to do business in, as well as any necessary paperwork for some types of businesses (LLC’s, corporations).
• When you go into business with someone, be cautious. It doesn’t matter how well you know someone. Make sure you get everything (partnership agreement, conflict resolution agreement, a rough business plan and operations plan, etc. signed before actually filing the paperwork to start the business. This is SO important.

Choosing the right business choice is a personal decision. Hopefully this list provided you with the knowledge and insight to make the best choice for your business.