Whether you’re looking to establish a new venture or taking your small startup to the next level, the first and foremost step is to register your company legally. To do that, you need to choose an ownership structure that supports your business needs and goals. Below are eight main types of business ownership that you must know before registering your business.
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8. Sole Proprietorship
As the name suggests, a sole proprietorship is a business structure in which the company is run and owned by a single individual or sole trader. It is the most uncomplicated form of business ownership.
Requirements include registration with related authorities (depending on the country), which protects the business name from being copied and allows the owner to hire employees.
Simple and easy: Registering a business as a sole proprietorship is perhaps the simplest of all. The only paperwork includes a simple registration and relevant licenses to conduct business. It is also the least expensive type of business ownership.
Complete control: As the only owner, sole proprietors have complete control over their business and business decisions—no general meetings and votes.
Simplified taxation: Sole proprietorships are not subjected to separate taxation as profits from these businesses are legally assessed as the owner’s personal income and thus only liable for a single tax.
Full legal/financial liability: There is no legal distinction between a sole proprietor and their business. It means that if legal action or any type of lawsuit is filed against a sole proprietorship, it will be personally launched against the owner similarly if the business defaults on its loans/credits, the owner’s personal property and assets can be seized by creditors to recover their claims.
Limited funding options: In most cases, sole proprietorships do not qualify for loans or other types of business fundings from traditional institutions, including banks, due to high credit risk. It makes difficult for such business to acquire large fundings.
Sole Proprietorship in the United States
In the U.S, sole proprietors are not required to go through any mandatory business registration. However, depending on the industry, they may need to acquire licenses to conduct business operations.
Under the 2017 Tax Cuts and Jobs Act, sole proprietorships and other flow-through entities are qualified for up to 20 percent tax deductions from income.
What is A Flow-through Entity?
A flow-through or pass-through entity is any legal business organization whose profits are treated as direct income of its members or partners. Such entities avoid double taxation (corporate income tax) since their members are only taxed on their flow-through income.
Sole Proprietorship in Europe and other parts of the world
Most European countries, including the United Kingdom, require individual owners (sole proprietors) to enroll for the Value Added Tax (VAT). Owners become liable for VAT or GST after they reach a set annual revenue threshold. This system is also practiced in Australia and Malaysia.
A partnership, in its most basic form, is any business owned by two or more individuals. If two people start a new business venture without registering with the local authorities, that business will be considered a partnership by default.
While not a legal requirement, partnerships are often built on formalized partnership agreements outlining the rights and obligations of each partner. Partnership agreements can also be drawn between two separate companies before starting a joint venture or forming a consortium.
There are two forms of partnerships; general partnership and limited partnership. A limited partnership is different from a limited liability partnership, which we will discuss in the next segment.
Anyhow, the difference between a general partnership and a limited one is that the latter has at least one general partner and one limited partner (with no management authority and liability). Business entities such as law firms and accounting firms are typically organized as partnerships.
Advantages Of Partnership
Simplicity: Partnership businesses enjoy the same advantages as that of Sole Proprietorships. It doesn’t require any legal formalities or paperwork for registration except for partnership agreements. As a flow-through, partnership entities do not pay corporate taxes.
Full control: In partnerships, owners enjoy full control over every aspect of their business. New partners can be easily introduced in this ownership structure.
Disadvantages Of Partnership
Financial risks and liabilities: Joint owners in a partnership are fully exposed to legal/financial liabilities that may arise during the course of the company’s operations. However, these risks can be reduced to some extent by insurance policies and carefully negotiated partnership agreements.
Partnership Laws in the United States: Unlike most nations, partnerships are not federally regulated in the U.S. Instead, each state has its own set of written laws that govern such businesses.
Under the Uniform Partnership Act (including the 1997 revision), many U.S states have implemented standard, or similar, regulations regarding the formation, assets, and liabilities of general partnerships and limited liability partnerships.
6. Limited Liability Partnership (LLP) And LLLP
Kirkland & Ellis LLP, world’s largest law firm by revenue, office in Palo Alto | Image Courtesy: FT.com
The limited liability partnership (LLP) is a modified version of the limited partnership business structure in which partners enjoy the simplicity of flow-through taxation rules but also have limited liability. It can be described as a hybrid business ownership structure with elements of partnerships and corporations. However, unlike limited partnerships, LLPs are not available in every nation.
Advantages Of LLP
Liability protection: Unlike in ordinary partnerships, partners in an LLP have limited liabilities. It means every partner’s liabilities are limited to their invested amount in the business and are not extended to their personal assets. Moreover, each partner of an LLP is not personally liable for the negligence of another partner.
Flexibility: LLPs are considered flow-through tax entities, meaning they are not subjected to corporate income tax.
Disadvantages Of LLP
Complexity: Often, partners in an LLP, are required to establish complex sets of regulations and provisions outlining the responsibilities of each partner and what business decisions one can take or cannot take. Furthermore, many U.S states have a complicated tax filing system in place for LLPs, which could be a disadvantage.
Availability issues: Not U.S states recognize limited liability partnership ownership structure.
LLPs in the United States: Not all states in the U.S allow businesses to register as a limited liability partnership. And each state has its own rules regarding the formation of an LLP and the liability of its partners.
For instance, in California and Nevada, LLPs can only be used by professional services, such as accounting, architecture, and law firms. LLPs usually require registration with the office of the secretary of state.
In some states, including Delaware, Texas, and Virginia, businesses can be registered as limited liability limited partnerships (LLLPs). It is a slightly modified variant of the limited partnership, in which general partners are shielded from being personally liable for obligations and debts of a limited partnership.
5. Limited Liability Company (LLC)
A limited liability company can be best described as a hybrid business entity with traits of both partnerships (or sole proprietorship) and corporations. It combines the flow-through taxation feature of partnerships with the limited liability status of corporations. However, the most important characteristic of LLCs is their flexibility.
Under the limited liability company structure, a business may elect its corporate tax status; whether it should be taxed once before the distribution of its income among the members and then again after the income is distributed (double-taxation as in C corporations), or that the profits (or losses) flow-through to the members (as in S corporations).
Flexible taxation along with the limited liability for owners makes LLC a popular choice among small businesses.
The ‘limited liability company (LLC)’ is a U.S specific form. In most other english speaking countries, such ownership structure is known as private limited company.
Advantages of LLCs
Limited liability: By forming an LLC, owners can legally separate the business entity from their personal assets. Members are partially or completely (depending on local laws) shielded against any legal action or credit claims that are bought up against an LLC. However, members of LLCs can incur personal liability under certain circumstances.
Flexible tax system: A multi-member LLC can elect how the firm is taxed, whether as a flow-through entity, such as partnerships and S corporations, or as a C corporation that is subjected to federal corporate income tax.
Flexible ownership: Several U.S states allow LLCs to be formed by a single person. States also do not restrict the number or type of member an LLC can have. Members can be individuals, organizations, or other businesses.
Disadvantages of LLCs
Unclear regulations: One of the biggest disadvantages of LLCs is their unclear or complex management structure. Unlike corporations, which usually have clearly defined state laws and provisions for both the shareholders and the business entity, most states do not provide adequate protective laws and regulations for LLCs.
In such cases, it is critical for the members of an LLC to establish the ‘operating agreement,’ a rule book of sort that outlines rules and provisions for the internal operations for the company.
Jurisdiction issues: A U.S-based LLC is usually treated as a corporation, which is subjected to additional taxes when operating outside the United States. This happens in countries where limited liability company structure is not legally recognized, such as Canada.
Different Variations of LLCs
Several variations of LLCs have emerged over time. A few of them are as follows,
Series LLC is a specialized and more complex form of the LLC ownership structure that allows a business to compartmentalize or isolate its assets from one another. In essence, a business organized as a series LLC can create multiple secondary LLCs that act like subsidiaries.
By legally isolating each of its assets and business units into these subsidiary LLC, a series LLC can ensure that foreclosures and legal liabilities of one business unit remain restricted and do not affect its other assets.
The L3C, or low-profit limited liability company, is a management structure that allows social enterprises to attract private investments while making small profits from their operations. An L3C is essentially a hybrid entity that enjoys the legal and financial flexibility of a standard LLC and the social status of a nonprofit organization.
4. C Corporation
Walmart Inc., the world’s largest company by revenue | Image Courtesy: Wikimedia Commons
A corporation is a business entity that is legally separate from its owners, who have a varying level of control over its operations. These owners can either be classified as members or shareholders, depending on the type of corporation.
The management structure of corporations allows their owners to avoid personal liability for the company’s debts and legal actions while taking part in the profits.
To form a corporation, a business usually needs to file articles of incorporation with the respective state and then appoint or elect a board of directors to supervise and oversee its day-to-day operations.
Depending on how it is taxed, a corporation can be classified either as a C corporation (C corp) or S corporation (S corp). A C corporation is subject to double or separate taxation, i.e., the business profits are first taxed at a corporate level (corporate income tax) then at a personal level after distributing its earning and profits among the shareholders.
C corporations are incorporated under the tax rules defined by Chapter 1, Subchapter C of the Internal Revenue Code. Every new corporation, by default, is treated as a C corporation unless it chooses to be treated as an S corporation.
Advantages of C corporation
Limited Liability: Both C corporation and S corporation allow shareholders or members to limit their liability up to their investment in the business. They are personally liable for commitments/obligations of the business to the third party.
Business Scalability: C corporations have no shareholders limit. It means that a C corporation can have any number of shareholders allowing the business to expand at a fast pace without structural changes. All publically traded corporations are C corporations
Easy access to investments: Corporation business ownership structures are much better at attracting investments from different sources than sole ownership and partnerships.
Disadvantages of C corporation
Tighter regulations: Unlike LLC, or more informal ownership structures, C corporations are required to file their earnings, profits, and other business metrics at regular intervals. They are subjected to tighter oversight than LLCs.
Double taxation: C corporations are taxed at two levels; first at corporate and then personal levels. A C corporation pays corporate income tax on its revenue before the distributions of its profits (usually defined as dividends in the U.S) among shareholders, who then pay personal income taxes on those gains.
Less individual control: The management structure of C corporations, which includes a board of directors and a large number of shareholders, restricts any one individual from controlling the entire business.
3. S Corporation
Unlike C corp, an S corporation is treated as a flow-through taxation entity that does not pay corporate income tax. Instead, the profits (or losses) are directly passed through its shareholders, who then file individual income tax returns on that income.
S corporations are taxed under Subchapter S of IRC and are ideal for small businesses. A C corporation can choose to be taxed as an S corporation if certain conditions are met.
Advantages Of S Corporation
Limited Liability: Like C corporations and LLCs, the structure of S corporations create a legal distinction between the business and its owners and thus limiting their liability.
Easy taxation: As a flow-through tax entity, S corporations do not pay corporate income tax relieving such corporations of extra tax filing burdens.
Disadvantages of S Corporation
Management restrictions: An S corporation can have no more than a hundred shareholders at a time. And those shareholders must be residents or U.S citizens. Moreover, such corporations can only issue a single type of stock.
Complex state laws: Several U.S states, including California, Delaware, and Pennsylvania, require businesses to fulfill certain requirements to be recognized as an S corporation. For instance, the Franchise Tax Board of California imposes a 1.5% franchise tax on the income of every S corporation in the state.
New York corporate website
The New York State does not recognize S corporation as a flow-through tax entity meaning such corporations are required to pay corporate tax like C corporations.
2. Benefit Corporation Or B Corp.
A benefit corporation (B.corp) is a corporate entity that has declared to pursue social and environmental activities on top of focusing on corporate profits and appreciation of shareholder value over the long term.
Benefit corporations are almost similar to C corporations except for a major difference. While ordinary corporations can also make social and environmental commitments, corporations usually stray away from such decisions due to their foremost legal obligation to maximize shareholders’ profits.
A benefit corporation addresses this problem by extending the legal obligation of the board of directors to pursue the interests of non-financial stakeholders, including employees and customers.
A corporation may convert into a benefit corporation by altering its bylaws to state that the business is a public benefit corporation. The firm must also specify the social benefit projects that it will pursue.
Advantages Of B.Corp
Limited Liability: Like other types of corporations, benefit corporation stakeholders also enjoy limited liability.
Tax benefits: While public benefit corporations must abide by the tax regulations of either C corporation or S corporation, they enjoy regular tax deductions due to their philanthropic contributions to society.
Disadvantages Of B.Corp
Restricted availability: As of July 2021, the benefit corporation structure is legally recognized in only 37 U.S states. Moreover, each state has its own regulations concerning the formation, reporting of social benefits by a b.corp, making it more complex to form and run such a business.
1. Nonprofit Organization
A nonprofit organization or institution is any legal entity that works exclusively on charitable missions. Unlike other types of business ownership in this list, nonprofits are not profit-driven and operate solely on donations, government fundings, corporate sponsorships, fundraising, and revenue from merchandise sales.
Contrary to popular beliefs, a nonprofit organization can make profits. As a matter of fact, nonprofits are required to be fiscally responsible and, in many cases, are urged to be a more businesslike entity.
Nonprofit Corporation in the United States
In the United States, incorporation for nonprofit entities is the same as other corporation types, including filing the articles of incorporation with the office of the secretary of state and appointing a board of directors or trustees.
A nonprofit corporation may be exempted from federal income tax under Section 501(c) of the IRC. Since the federal government grants the tax exemption status of a nonprofit corporation, not all incorporated nonprofit entities are exempted from taxes.
Frequently Asked Questions
What Is Ownership Interest?
Ownership interest is any stake owned by an individual or an entity in a business, real estate, and other types of assets. In LLCs and corporations, the stakeholders have varying amounts of ownership interest. While in sole proprietorships, only one individual has the ownership interest.
In business, ownership interest can be categorized into two types; passive interest (when an investor owns less than 20% stake) and controlling interest (owns a 50% stake or more).
What are the Main Types of Business Ownerships?
The main types of business ownership that are recognized in most countries are sole proprietorship, partnership, and limited liability company (LLC). Corporation, on the other hand, is a U.S specific form of ownership structure.
In the United Kingdom, corporation-like business structures are formally known as PLC or public limited company. In countries like France, Spain, and Poland, they are simply designated as S.A.
What is the Best Legal Form of Business Ownership?
When you consider limited liability, ownership structures like limited liability partnerships, limited liability company, and corporations are ideal for your business. However, such forms of ownership have complex rules and regulations that they must abide by.
While choosing an ownership structure, business founders must carefully review each of their advantages and drawbacks and how they can be beneficial for your company.