Looking to start your own business? Congratulations! You’re onto something big – entrepreneurs like yourself are truly fueling the economy. To help you along, we’re here to explain the different types of businesses that you can choose from.
To clarify, there are six basic types of businesses:
The sole proprietorship is the simplest business form under which one can operate a business. The sole proprietorship is not a legal entity. It simply refers to a person who owns the business and is personally responsible for its debts.
Advantages for sole proprietors:
- Minimum formation costs
- Less formal business requirements
- No corporate tax payments
- Complete control over a business
- Owner has power over sale or transfer of assets
- No need to wait on a decision from others
Disadvantages for sole proprietors:
- Sole proprietor is responsible for the business obligations (including any debts).
- Sole proprietor must file any forms needed for the business name and operations.
- Sole proprietor is responsible for all monies and debt for a business, even under a separate marketing name.
- Sole proprietors’ money is generally tied into the business. There usually is no legal separation between personal funds and business funds. This can become a problem if the owner faces legal actions about the business. Personal funds can be at risk for a sole proprietor.
- Pressure and Time – A sole proprietor faces the disadvantage of working too hard on the business. It’s a possibility that his personal life and family life could suffer. Vacation time can be interrupted by word demands.
- A business set up as a sole proprietorship is not taxed, as the profits and losses are assumed by the sole proprietor.
A business organization in which two or more individuals manage and operate the business. Both owners are equally and personally liable for the debts from the business. Partnerships are easy to form. There is no minimum capital requirement. Only two people are needed to incorporate the partnership.
Advantages of a partnership:
- two heads (or more) are better than one
- your business is easy to establish and start-up costs are low
- more capital is available for the business
- you’ll have greater borrowing capacity
- high-calibre employees can be made partners
- there is opportunity for income splitting, an advantage of particular importance due to resultant tax savings
- partners’ business affairs are private
- there is limited external regulation
- it’s easy to change your legal structure later if circumstances change.
Disadvantages of a partnership:
- the liability of the partners for the debts of the business is unlimited
- each partner is ‘jointly and severally’ liable for the partnership’s debts; that is, each partner is liable for their share of the partnership debts as well as being liable for all the debts
- there is a risk of disagreements and friction among partners and management
- each partner is an agent of the partnership and is liable for actions by other partners
- if partners join or leave, you will probably have to value all the partnership assets and this can be costly.
Partnerships when given the feature of limited liability, the LIMITED LIABILITY PARTNERSHIPS came into picture. LLP is a separate legal entity and which can be formed in India by minimum of two persons with a motive of earning profit.
Advantages of an LLP:
- Limited liability protects the member’s personal assets from the liabilities of the business. LLP’s are a separate legal entity to the members.
- Flexibility. The operation of the partnership and distribution of profits is determined by written agreement between the members. This may allow for greater flexibility in the management of the business.
- The LLP is deemed to be a legal person. It can buy, rent, lease, own property, employ staff, enter into contracts, and be held accountable if necessary.
- Corporate ownership. LLP’s can appoint two companies as members of the LLP. In an LTD company at least one director must be a real person.
- Designate and non-designate members. You can operate the LLP with different levels of membership.
- Protecting the partnership name. By registering the LLP at Companies House you prevent another partnership or company form registering the same name.
Disadvantages of an LLP:
- Public disclosure is the main disadvantage of an LLP. Financial accounts have to be submitted to Companies House for the public record. The accounts may declare income of the members which they may not wish to be made public.
- Income is personal income and is taxed accordingly. There may be tax advantages in registering as a company, but this will depend on your personal circumstances.
- Profit can not be retained in the same way as a company limited by shares. This means all earned profit is effectively distributed with no flexibility to hold over profit to a future tax year.
- An LLP must have at least two members. If one member chooses to leave the partnership the LLP may have to be dissolved.
A corporation, is a fully independent business (when public) that’s made up of multiple shareholders who are provided with stock in a new business. Most common is what’s known as a “C Corporation,” which allows your business to deduct taxes much like an individual – the only problem with this is that your profits will be taxed twice, both at the corporate level and at the personal level.
Advantages of a Corporation:
- Limited liability: The shareholders of a corporation are only liable up to the amount of their investments. The corporate entity shields them from any further liability.
- Source of capital: A publicly-held corporation in particular can raise substantial amounts by selling shares or issuing bonds.
- Ownership transfers: It is not especially difficult for a shareholder to sell shares in a corporation, though this is more difficult when the entity is privately-held.
- Perpetual life: There is no limit to the life of a corporation, since ownership of it can pass through many generations of investors.
Disadvantages of a Corporation:
- Double taxation: Depending on the type of corporation, it may pay taxes on its income, after which shareholders pay taxes on any dividends received, so income can be taxed twice.
- Excessive tax filings: Depending on the kind of corporation, the various types of income and other taxes that must be paid can require a substantial amount of paperwork.
- Independent management: If there are many investors having no clear majority interest, the management team of a corporation can operate the business without any real oversight from the owners.
Limited Liability Company (LLC)
An LLC is a newer type of business that is a blend between a sole proprietorship and a corporation. Instead of shareholders, with LLCs, owners are referred to as members. No matter how many members a particular LLC has, there must be a managing member who takes care of the daily business operations. The main difference between an LLC and a corporation is that LLCs aren’t taxed as its own business entity. Instead, all profits and losses are moved from the business to the LLC members, who then, instead of having to report business finances on a corporate return, can report profits and losses on a personal federal tax return.
Advantages of an LLC:
- It limits liability for managers and members.
- Superior protection via the charging order.
- Flexible management.
- Flow-through taxation: profits are distributed to the members, who are taxed on profits at their personal tax level. This avoids double taxation.
- Good privacy protection, especially in Wyoming.
- This is a premier vehicle for holding appreciating assets, such as real estate, stock portfolios, and intellectual property.
- Extraordinary flexibility in the ability to allocate profits and losses to members in varying amounts.
Disadvantages of an LLC:
- Some states, including California, charge extra fees for operating an LLC.
- Income splitting is available, but unlike an S Corp, in a business operating as an LLC all income may be subject to payroll or self-employment taxes.
- Some states do not allow professional groups (i.e., doctors or dentists) to operate through an LLC.
- Transferability restrictions – consent of membership is required for each and every transfer of membership interests.
- Single Member LLCs face reduced asset protection. Many states do not honor asset protection for LLCs with a single owner.
The last on our list of six popular types of business is what’s known a cooperative, or a business that’s fully owned and operated for the benefit of the members of the organization that use its services. In other words, whatever is earned by the cooperative is then shelled out among the members themselves, and aren’t required to be paid out to any external stakeholders, etc. Unlike other types of businesses, which have shareholders, cooperatives sell shares to cooperative “members,” who then have a say in the operations and direction of the cooperative itself. The main difference in the process of becoming a cooperative, as opposed to the other types of businesses listed, is that your organization must create bylaws, have a membership application and have a board of directors with a charter member meeting.
Advantages of a cooperative:
- A cooperative organization is owned and controlled by members.
- It has a democratic control: one member, one vote.
- This type of organization has a limited liability.
- Profit distribution (surplus earnings) to members is carried on in proportion to the use of service; surplus may be allocated in shares or cash.
Disadvantages of a cooperative:
- A cooperative organization entails longer decision-making process.
- It requires members to participate for success.
- Extensive record keeping is necessary in this form of organization.
- It has less incentive, and there’s also a possibility of development of conflict between members.
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