Types of Business - Factors to Consider

Startup, Liability, Continuity, Taxes, Transfer, Profit/Loss

Startup
Types of Business - Factors to Consider. Xavier Arnau / Getty Images

You are ready to start a business and you want to select a business type. Use this list of factors to narrow down those that are important now and that may be important later. For example, the cost of startup is important now, but tax may be important later. Understanding the factors you consider most important will help you select a business type.

Sole Proprietorship

  • One owner
  • Complexity/Cost of Startup. No state registration, only business license. No attorney needed.
  • Company legal record keeping/reporting complexity. No company records needed (annual report, minutes of meetings, etc.). No reporting to state regulatory agency for business annual report or other general business requirements.
  • Income tax. Schedule C, individual rate
  • Continuity - Dissolves on death, withdrawal of owner
  • Distribution of profits/losses - Owners gets all profits, absorbs all losses
  • Transfer of interest - owner can sell at any time
  • Tax position of individual - self-employed; pay self-employment tax on profits
  • Ability to raise capital/get a business loan. Low; banks want a formal structure. To get investors, need a formal structure.
  • Separation of shareholders and managers. No separation.

Partnership

  • Several owners
  • Complexity/Cost of Startup. State registration, partnership agreement; attorney needed
  • Company legal record keeping/reporting complexity. Minutes of partnership meetings should be kept, changes in the partnership agreement. Some states require an annual report, fee payment.
  • Income Taxes - Schedule K-1 for individual partners, based on distributive share
  • Continuity - Depends on partnership agreement, may dissolve if no agreement
  • Distribution of profits/losses - Apportioned by partnership agreement
  • Transfer of interest - partners may sell interest, based on partnership agreement
  • Tax position of individual/s - self-employed; pay self-employment tax on share of profits
  • Ability to raise capital/get a business loan. Moderate if use limited liability partnership form.
  • Separation of shareholders and managers. General partners usually have management roles; limited partners have limited or no management roles.

LLC

  • One or more owners (members)
  • Complexity/Cost of Startup. State registration, operating agreement; attorney needed for operating agreement
  • Company legal record keeping/reporting complexity. Minutes of member meetings should be kept, changes in operating agreement. Some states require an annual or biennial report, fee payment.
  • Legal Liability - limited to investment
  • Income Taxes - single member taxed like sole proprietor; multiple-member taxed like partnership
  • Continuity - Depends on operating agreement, may dissolve if no agreement
  • Distribution of profits/losses - Apportioned by operating agreement
  • Transfer of interest - members may sell interest, based on operating agreement
  • Tax position of individual/s - self-employed; pay self-employment tax on share of profits
  • Ability to raise capital/get a business loan. Moderate. Banks accept for loans. Investors want corporate structure.
  • Separation of shareholders and managers. No separation.

C Corporation

  • No limit on number
  • Complexity/Cost of Startup. State registration, Articles of Incorporation, Bylaws. Attorney definitely needed.
  • Company legal record keeping/reporting complexity. Minutes of all meetings should be kept, corporate record book required, changes in bylaws must be recorded. Shareholder votes on changes. Some states require an annual report, fee payment, or franchise tax.
  • Legal Liability - corporation a separate entity, owners shareholders liable only to amount invested; officers may be personally liable
  • Income Taxes - taxed at corporate rate
  • Continuity - Not affected by loss of any one shareholder/director
  • Distribution of profits/losses - Paid to shareholders according to investment
  • Transfer of interest - shareholders may buy/sell stock at any time, unless restricted by agreement
  • Tax position of individual/s - Owners working in a corporation are employees, not self-employed
  • Ability to raise capital/get a business loan. Excellent for both loans, investors.
  • Separation of shareholders and management. Shareholders may be executives but separate liability.

S Corporation

  • Not more than 35 shareholders (plus other eligibility requirements)
  • Complexity/Cost of Startup. Attorney definitely needed.
  • Company legal record keeping/reporting complexity. Minutes of all meetings should be kept, corporate record book required, changes in bylaws must be recorded. Shareholder votes on changes. Some states require an annual report, fee payment, or franchise tax.
  • State registration, Articles of Incorporation, Bylaws, S corporation election
  • Legal Liability - corporation a separate entity, owners shareholders liable only to amount invested; officers may be personally liable
  • Income Taxes - Tax passed through to shareholders, based on stock held; generally no tax paid by corporation
  • Continuity - Not affected by loss of any one shareholder/director
  • Distribution of profits/losses - Paid to shareholders according to investment
  • Transfer of interest - Shareholders may buy/sell stock at any time, unless restricted by agreement
  • Tax position of individual/s - Owners working in a corporation are employees, not self-employed
  • Ability to raise capital/get a business loan. Excellent for both loans, investors.
  • Separation of shareholders and management. Shareholders may be executives but separate liability.

A Guideline for Business Type Selection
The type of business you start should match the complexity of your business.

  • If you are going to work from home and have no employees, you can probably start as a sole proprietor. If you want to look more official or you are worried about liability, start as an LLC.
  • If you are selling products, you plan on making these products yourself, and you plan to have employees, consider incorporating right away.
  • If you are going into business with another person, even your spouse, consider forming an LLC to limit liability, or a limited partnership.

Remember, you can always move up from a less complex business type to a more complex type as your business grows, you add employees, and your business becomes more profitable.