What are the types of businesses out there?
What are the different types of business structures?
How to choose the right one?
In this article, we will break down the notion of “types of businesses” so you know all there is to know about it!
We will look at the most popular types of business organizations such as corporations, partnerships, limited liability companies, sole proprietorships and the list goes on.
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What types of business are there
Every business is unique.
The type of business structure you choose to start, run and operate can have important consequences (positive or negative) in the future.
Choosing the right business structure and type of business can set you up for long-term success in your business.
In essence, the kind of business you choose can potentially affect:
- Your taxes
- Your business financing abilities
- Your administrative workload
- Your personal liability exposure
Let’s look at different types of business ownership and see what they are and how they function.
A corporation is a business entity that you must form by filing the necessary incorporation papers with the state.
Within the corporation classification, there are different types of corporations such as:
- C Corp
- S Corp
- B Corp
- Close Corp
- Nonprofit Corp
We’ll cover each of these types of corporate entities one by one.
A C Corporation or C Corp is a legal entity that is distinct and separate from its owners (shareholders).
It’s called a “C” corporation as fundamentally it is a “corporation” but is taxed under Subchapter C of the Internal Revenue Code.
Under Subchapter C, this type of corporation will report its corporate income to the IRS and directly pay taxes.
This is a suitable business type for those who intend to start or operate a business in medium or high-risk industries or markets.
Having its legal existence, a C Corporation can enter into business transactions, sign contracts, own assets, generate income, pay taxes, sue someone, get sued and so on.
This type of business can theoretically live forever.
In other words, a C Corporation can remain in business and operational for so long as it remains in good standing with state laws.
The shareholders may change, transfer their shares, sell them or even pass away.
However, the change in shareholder ownership does not affect the existence of the corporation.
An essential advantage of a C corporation is that it offers its shareholders liability protection against business losses, debt and liability.
On the flip side, C Corporations have an obligation to remain in compliance with state laws, keep an adequate record of the business, and keep up with their periodical filings.
C Corporations are also one of the most suitable types of businesses for those looking to find investors, get financing from venture capitalists or raise capital through the issue of equity securities.
It is relatively easy to issue shares of stock to investors and sell a percentage of the business in exchange for equity capital where the company would not have an obligation to reimburse.
One potential drawback to the C Corps is what’s called “double taxation”.
In other words, the C Corporation must pay corporate income taxes on its revenues (the first time its revenues are taxed).
Eventually, when it declares dividends to its shareholders to pass on profits to them, the shareholders will also be taxed on their personal income taxes (the second time the same revenue is taxed).
An S Corporation or S Corp is a legal entity that is distinct and separate from its owners just like a C Corporation.
It’s called an “S” corporation as it is a “corporation” as a legal entity but is taxed under Subchapter S of the Internal Revenue Code.
Under Subchapter S, this type of corporation can avoid double taxation by allowing its income to pass through to its shareholders.
In essence, the company’s revenues are taxed only once and directly in the hands of the shareholders’ personal income taxes.
This is essentially similar to how partnerships are taxed.
To take advantage of this pass-through taxation opportunity, the corporation must be eligible and must file its tax election with the IRS.
The tax election adds to the paperwork and complexity in forming a corporation compared to a C Corporation.
A company that does not expressly make an S Corp tax election with the IRS will be recognized as a C Corporation by default.
It’s important to note that some states recognize S Corporations, some do not and some tax them differently from the U.S. federal government.
It’s important to see what tax regimes will apply to your S Corporation.
To qualify as an S Corporation, you must not have more than 100 shareholders in your business and all of them must be U.S. citizens.
In addition to the pass-through taxation, an S Corporation will provide the same advantages as a C Corporation such as the business owner liability protection and business continuity in the event of shareholder change.
From a financing perspective, the S Corp can only have up to 100 shareholders.
Depending on how much you want to grow and scale the business, you will be limited at some point in time but you have enough room to grow.
Also, all investors or shareholders must be American.
This will eliminate the possibility of having foreign investors or venture capitalists in your business.
This type of company is suitable for those looking to have a corporation and benefit from pass-through taxation.
A B Corporation or B Corp (also known as a benefits corporation) is a legal business entity separate and apart from its shareholders just like a C Corp and S Corp.
However, where the benefits corporation is different is with respect to its mission, purpose and disclosure.
In essence, a B Corporation is driven by making a profit and a mission benefiting society.
As such, B Corporation business owners are required to earn a profit but advance the corporation’s mission and bring a positive contribution to society.
Some states require that the benefits corporations submit an annual benefits report providing public disclosure as to how they advanced their mission.
Close corporations are similar to B Corporations.
A corporation can be a “close corporation” if it does not exceed 35 shareholders and its shares are not authorized to be publicly traded.
These companies are typically operated by a few shareholders and are exempt from many rules and corporation formalities.
Nonprofit corporations (also known as 501(c)(3) corporations) are corporations driven by a mission and not profits.
Typically, nonprofit businesses can include religious organizations, charity, literary, educational or scientific missions.
Nonprofit corporations can benefit from various tax exemptions legally offered to them.
It must file the necessary paperwork with the IRS to get the nonprofit designation to benefit from such tax exemptions.
From a compliance perspective, a nonprofit entity will have similar obligations as a C Corporation.
In addition to that, it will also need to comply with additional rules and regulations with respect to how it has managed its revenues and profits.
A Co-op or cooperative is a business entity that is fully owned and managed for the benefit of the members using its service.
The difference between a cooperative with other types of businesses is that you must observe additional requirements such as having cooperative bylaws, a board of directors, a charter of member meetings and membership application.
Any profit or revenue generated by the cooperative will be distributed back to its members.
Each member of the cooperative must have shares in the cooperative and can exercise voting power.
Limited liability company
A limited liability company or LLC is a type of business entity that you can consider to have similarities with corporations and partnerships giving you some of the benefits of both forms of business types.
Just like corporations, LLCs offer its members liability protection.
In other words, the LLC owners (or members) cannot be personally held responsible for business debts, liability, financial obligations or losses.
Being a separate legal entity, the LLC shields the LLC members’ personal assets from the business creditors, lawsuits and seizure.
Just like partnerships, LLCs offer its members the advantage of benefiting from pass-through taxation.
In essence, the LLC will not pay corporate taxes.
The LLC income will be reported on each member’s personal income taxes who are considered self-employed individuals.
A limited liability company is different from a corporation because it does not theoretically have a “perpetual” life.
Depending on the applicable state laws, an LLC may need to be dissolved and formed whenever new members join the LLC or some members exit the business.
If you have more than one person looking to start a business, partnerships are the simplest forms of business structures available to you.
Partnerships can be a simple way for two or more individuals to get together and start a business to test their business idea before getting into the complexities of registering a company.
Typically, the partnership liability is equally divided between the partners.
However, business owners in limited partnerships can further define their roles and obligations in a partnership agreement.
There are three main categories of partnerships:
- General partnerships (GP)
- Limited partnerships (LP)
- Limited liability partnerships (LLP)
Partnerships are forms of business organizations commonly used by professionals such as lawyers, accountants, insurance brokers, real estate brokers, engineers or others.
Let’s look at each of these types of business organizations one by one.
General partnerships are simple forms of business structures allowing two more individuals to start a business.
In a general partnership, the partners equally own and operate the business.
Just like a sole proprietor, the general partners do not have personal liability protection.
As such, the partners are responsible for the acts and omission of the other partners and the business financial obligations.
There is no separation between the business assets and liabilities with the partners’ personal assets and liabilities.
This type of business structure is suitable for small businesses in low-risk markets or perhaps for individuals looking to test a business idea.
A general partnership does not have an obligation to register itself with the state.
Limited partnerships are a type of partnership similar to a general partnership but where not all the partners have unlimited liability.
In an LP, you have two types of partners: general partners and limited partners.
The general partners will have unlimited liability to cover the partnership’s financial obligations whereas the limited partners have limited liability.
Generally, the general and limited partners enter into a partnership agreement setting out the partnership’s internal rules, voting rights, entry and exit rules, and so on.
When a partnership agreement is entered into, the partnership will then have an obligation to register with the state in many states.
The partnership profits are typically passed through to the partners (pass-through taxation).
As such, the partners will report the partnership income on their personal income taxes.
An LP is a suitable business structure for those looking to find passive investors who will not participate in the business’s day-to-day operations.
Limited liability partnership
Limited liability partnerships are types of business enterprise similar to limited partnerships.
The most important difference is that all the partners benefit from limited liability protection whereas only limited partners benefit from this protection in limited partnerships.
Another notable difference is that the partners are not personally responsible for the other partners’ actions or omissions.
A sole proprietorship is one of the simplest types of businesses to start.
In fact, when you start operating a business or perform certain commercial activities, you are automatically consito be a sole proprietor.
A sole proprietorship is composed of one owner who owns 100% of the business.
Sole proprietorships are kinds of business structures that do not need to be registered or respect any formalities to be formed.
However, depending on what you are selling and where you are selling your goods, you may need to file for a business license.
The most significant advantage in operating as a sole proprietorship is that you can get started immediately as of today and have full control of the business.
The business owner fully owns the business and is the only person making all the business decisions.
A business owner can operate a sole proprietorship under a fictitious name or trade name instead of his or her personal name.
To file for a fictitious name (“DBA” or “Doing Business As”), you’ll need to file some paperwork with the state and ensure the trade name is available.
However, the simplicity of sole proprietorships comes at a cost.
Sole proprietorships are types of businesses that do not offer business owners limited liability protection.
In other words, a sole proprietor’s personal assets (home, car, savings, investments or other) are exposed to business creditors.
If the business is unable to pay its debts, assume its financial obligations or manage its liabilities, the business creditors can come after the business owner’s personal assets to recover their losses or get damages.
Furthermore, investors and financing organizations typically do not invest or finance sole proprietors.
As such, it is not possible to easily sell a portion of the business to an investor to raise capital.
You may consider a sole proprietorship as a business structure if you are going to have a micro-business or a side-hustle earning you some money in a very low-risk fashion.
Types of business FAQ
What type of business should you start
There are different corporation types, business entity structures and classifications of businesses.
The type of business entity you choose to run your business can have an important short-term and long-term impact on your business.
Here are the different types of business you can start:
- Sole proprietorship
- Limited liability company
- Nonprofit organization
What is the most common form of business ownership
The majority of businesses are considered small businesses composed of sole proprietorships, self-employed individuals and small businesses.
As such, sole proprietorships and small businesses form the biggest percentage of businesses in the United States.
According to the U.S. Small Business Administration’s small business profile report, in 2019, 30.7 million small businesses were in operations representing 99.9% of the United States businesses.
Small businesses employed more than 59.9 million people.
How to choose a type of business
There are generally a few factors that you should consider when choosing a type of business:
- Ownership structure (how many people will own the business)
- Personal liability (will you have limited liability protection or not)
- Taxes (will have corporate taxes to pay, personal taxes, self-employment taxes or will you be tax-exempt)
- Financing (are you going to finance the business yourself or will you need banks or investors to invest in the business)
Although there may be more factors, these are four important considerations in selecting a business type.
Some other considerations can be:
- Will you be hiring employees?
- Are you looking to run a business for profit or for a social mission?
- Are you looking for future investors or partners?
- Do you want flexibility in ownership structure to be able to transfer and assign all or part of the business to others?
- Are you willing to handle the paperwork of a registered business?
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