Choosing the right form of organizational structure for your business is of utmost importance. This single decision can have a major impact on almost all aspects of your business operation, and should be made with due diligence.
In this article, we will discuss the major forms of business organization available, as well as the advantages and disadvantages of each. This will help you gain clarity on the form which matches your specific requirements and business objectives.
A Sole Proprietorship is the simplest form of business organization, and is widely used by smaller businesses starting out. A sole proprietorship has a single owner with no legal distinction separating them from the business. The owner is also the sole beneficiary of the profits, which are only taxed once as income. A sole proprietorship has no lifetime beyond that of the owner, as its existence is entirely dependent on the owner.
Partnerships are similar to sole proprietorships except for the fact that they involve two or more legal entities (which can be either corporate or natural persons) sharing ownership of a business. As with sole proprietorships, there is no legal separation between the business and its partners.
When forming a partnership, the partnership agreement should clearly lay out the responsibilities of each partner, the amount of authority they have, and the share of profits and liabilities that each partner is due.
There are two main types of partnerships: General Partnerships and Limited Partnerships. In a general partnership, all partners are entirely liable for the business’ debts and losses, and so there is little protection from liability. On the other hand, a limited partnership allows for limited partners who act only as investors. They have no managerial power, and their liability is limited to the amount that they invest in the partnership. However, even limited partnerships have to have at least one general partner.
A corporation is simply a type of business which is considered to be a separate legal entity from its owners. As individual entities, corporations enjoy many of the same rights as natural persons. Corporations can own assets, file lawsuits or be sued, enter into contractual agreements, and pay their own taxes.
The key feature of corporations is that they exist independently of their owners. This means that they can continue to exist even when ownership changes. Importantly, it also provides limited liability protection to its owners, as it is responsible for its own debts and losses.
There are two main types of corporations: C-corporation and S-corporation.
C-corporations are taxed separately from their owners. This can either be a benefit or a disadvantage. It can be advantageous when corporate tax policies are favourable for the C-corp and allow for additional tax breaks. It can be a disadvantage in that it can lead to double taxation, first incurring corporate tax and then again incurring income tax when profits are distributed to the owners.
S-corporations have similar limited liability features to C-corporations; however, the profits are not taxed separately. All profits/losses are immediately treated as distributions, and the owners are then solely liable for paying taxes on these distributions. This can help to avoid double taxation.
A Limited Liability Company (LLC) is strictly a special type of corporation; however, it has many unique characteristics. It has become such a popular entity that it is often seen as its own distinct class of business.
The best way to understand an LLC is that it is a kind of hybrid between a partnership and a corporation, essentially offering the best of both worlds. As with other types of corporations, LLC’s are separate legal entities which offer limited liability protection to their owners. At the same time, they provide similar levels of flexibility, affordability, simplicity, and tax advantages of a partnership.
Each form of business organization differs greatly in terms of the following features:
The right type of business structure for you will depend greatly on your own personal situation and requirements. It is also important to note that the specific characteristics of each of these types of organizations can vary widely across different jurisdictions.
Therefore, it is strongly advised to seek the guidance of an expert when setting up your perfect business structure, irrespective of the type you choose. This can help ensure you are able to choose the right type of business to maximise your benefits, as well as to provide the necessary support with the formation process.
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