Business structure describes the organizational structure, legal status, and how much liability an owner assumes. It is a crucial part of dictating a company’s legal and operational framework.
Choosing a business structure that is efficient, practical, and suited to a company’s best interests is fundamental to its success.
When a business undertakes commercial activities – such as capital raising, marketing, and tax payments – its structure becomes integral to both immediate and long-term success.
Knowing which options are on offer and the pros and cons of each is important when making the right choice. In the US, there are several key legal entities a business owner can be capable of forming. The most common ones are Sole Proprietorship, Partnership, Limited Liability Company (LLC), and Corporation.
In relation to initial setup, ongoing administration, and balance sheet implications, each business structure has varying levels of complexity which must be taken into account by owners.
Entrepreneurs must consider the ongoing implications of a truly effective business structure. It is a decision that can change the entire direction of a company. This article will document some of the business structures available, including examples of each, as well as pros and cons, to illustrate their effective use.
Business structures that feature the simplest setup processes are Sole Proprietorships and Partnerships. However, Corporations and LLCs can provide greater legal protection for owners.
A Sole Proprietorship is the simplest business structure to establish. The unincorporated structure revolves around a registered person, officially responsible for the operational effectiveness of the business, as well as ongoing adherence to relevant laws and regulations.
Perhaps the most distinctive aspect of being a Sole Proprietor is that the business and the owner are not separate legal entities. This can result in the registered owner being held personally liable for the enterprise’s assets and liabilities.
For a company in financial distress, this can put the owner in a difficult position. Personal assets could be used to offset outstanding debts or obligations. However, a Sole Proprietorship does have its benefits. The business structure is the least complicated to establish, including minimal fees at the outset and low barriers to entry – almost anyone can be a Sole Proprietor.
Furthermore, the business owner is likely to benefit from tax write-offs, simpler tax filings, and no requirement for shareholder meetings.
Sole Proprietorships are smaller in scale and used by those who want to maximize control over their business. Important organizational decisions can be made by the owner(s), so control of the business can remain in the owner(s) hands. Examples include small independent stores, freelance contractors – such as writers and IT Consultants – and couples who run a business together.
Lower initial and ongoing costs also mean Sole Proprietorships can encourage business owners to launch regardless of the size of their budget.
The key characteristics of a Partnership are somewhat obvious – it is a business structure designed for two or more people. When a person wishes to embark on a joint enterprise, they will come to a simple agreement as part of an official Partnership.
Several positives come with this type of business structure, and many of these pros overlap with the benefits of establishing a Sole Proprietorship. For this reason, there are multiple similarities between a Sole Proprietorship and a Partnership.
The most notable similarity – which doubles up as a potential drawback – is that the participants in a Partnership do not have a separate legal identity from the company. In financial distress, the partners of an organization will be personally liable for any of the outstanding debts and obligations incurred by the company.
The owners and the business entity are treated as one and the same. In addition, any profits or losses will be directly passed on to the partners.
A negative which does not exist as prominently within a Sole Proprietorship is the potentially adverse effect of entrenched collaboration. If a disagreement, or something more serious, were to occur between partners, the operational effectiveness of the business – as well as its capacity to generate profitable cash flows – could be seriously impacted.
However, as with a Sole Proprietorship, Partnerships are relatively easy to set up. Partnerships are also more likely to benefit from special taxation arrangements.
Limited Liability Company (LLC)
As the name suggests, a Limited Liability Company (LLC) describes a business structure that limits the legal liability of the relevant person, equivalent to the sum of their investment or stake in the company. During periods of financial distress, an LLC will directly protect a business owner from the debts or obligations incurred by the organization.
Although regulation in the US varies from state to state, most owners will not be held personally responsible when a company’s liabilities are recalled.
Generally, most persons are eligible to become “members” of an LLC. This can include individuals, corporations, foreign entities, and even other LLCs. The exception to this is banks and insurance firms, which are prevented from becoming members of LLCs. As well as limited liability, there are multiple other benefits to successfully establishing an LLC.
In comparison to establishing a Corporation, an LLC is easier and less complex. Furthermore, flexible business structures can be combined with a lower rate of tax.
Businesses that may prefer to register with their chosen state as an LLC can include professional services firms, such as accounting and law firms. However, despite similar benefits to a Partnership or Sole Proprietorship, LLCs can incur additional complications.
Company accounts will be made public, and owners will not have as much control as Sole Proprietors, and compliance with regulatory and legal requirements may make it necessary to hire a registered agent.
A Corporation is an entity distinct from its owners, taking on a new legal persona. The new legal identity can enter into contracts, be sued, initiate litigation, own assets, and pay taxes. Corporations possess many of the same rights and responsibilities as individuals. Similar to an LLC, a Corporation offers owners limited liability.
It is the Corporation itself that will be pursued for its assets if in financial distress and shareholders are largely protected (although they may lose their investment).
Larger businesses would most likely choose to structure themselves as a Corporation. Giants such as Microsoft, Apple, and Alphabet Inc. (Google) are all Corporations. Corporations are established when a group of shareholders incorporates the business as a result of their stake in the company and the pursuit of a common goal.
Not all Corporations have to be created in pursuit of profit. Charities are often registered as Corporations and are, of course, Not-for-Profit organizations.
Establishing a Corporation is a complex, expensive, and time-consuming process. This would be an inappropriate business structure for a small business owner with a low revenue stream and no prospect of growth. Corporations can also either be private or public.
Private corporations are normally incorporated companies whose shareholders can be as many as a few or several dozen. Public companies have thousands of shareholders. Floating a company is a process with substantial regulatory requirements.
The type of business structure an entrepreneur chooses is a direct reflection of the industry they are in, the size of the company, and the direction the owner(s) want to move their business towards. Sole Proprietorships tick numerous boxes for those seeking complete control and generous tax write-off opportunities.
However, if business owners instead want to prioritize protection from personal liability in the event of financial distress, as well as a flexible business structure, an LLC or Corporation might be appropriate.
An intimate awareness of what a business needs and how the owners want to interact with the entity will result in an informed choice being made in relation to the business structure, which is crucial for the success and viability of any company. Ultimately, the primary function of a business – regardless of structure – is to generate cash.
Choosing the right business model will directly impact the ability of the company to generate revenue effectively. It requires thought, planning, and careful implementation. So choose wisely.
This article was produced and syndicated by Wealth of Geeks.
Michael launched Wealth of Geeks to make personal finance fun. He has worked in personal finance for over 20 years, helping families reduce taxes, increase their income, and save for retirement. Michael is passionate about personal finance, side hustles, and all things geeky.
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