Different types of business ownership for small business owners
When you start your small business, it can be confusing to know exactly what kind of business structure to start. Should you stick with a sole proprietorship? Go in with a partner? File for LLC or corporation status? It’s not a small decision. How you organize your company can affect everything from your personal liability and day-to-day operations all the way down to how much money you’ll make after taxes.
So what are the different types of business ownership? And what is the best form of business ownership for small businesses? Let’s talk through the most common forms of business ownership—and then we’ll discuss how to find the one that’s best for you.
- The various kinds of business ownership
a. Sole proprietorship
b. General partnership
c. Limited partnership
f. Limited liability company (LLC)
g. Business entities summary
- How to choose a business structure for your small business
a. Ownership and control factors
b. Taxation factors
c. Liability and risk factors
d. Expense and paperwork factors
e. Continuity factors
1. Here are the various types of business ownership
First, let’s define what we mean when we use the term “business entity,” or “business type,” or “ownership structure”—they’re all terms that mean, simply, how your business is organized. More specifically, they indicate how the government will view who owns your business, who is responsible for your business’ liability, and how your business should be taxed.
Broadly speaking, there are 4 different types of business structures: sole proprietorship, partnership, corporation, and LLC. Let’s talk about each of them (as well as a few variations).
a. Sole proprietorship
What’s a sole proprietorship?
A sole proprietorship is pretty much the simplest form of business structure—it’s a business owned by one person that is unincorporated (which just means that it’s not a separate legal entity from the person who owns it).
What are the advantages of a sole proprietorship?
- Simplicity—you’ll get a lot of the benefits of running a small business without a lot of the hassle. A sole proprietorship is the easiest kind of business to start, by far, because you don’t have to take any formal action or file any paperwork to start one. In fact, if you’re already selling a service or a good for money, you’ve automatically formed a sole proprietorship. (Congrats!)
- It’s inexpensive—there’s no fee to start a sole proprietorship
- Uncomplicated taxes—Since a sole proprietorship isn’t taxed separately, you can just deduct most business losses on your personal tax return. No extra tax form required.
But there is one major disadvantage to a sole proprietorship.
What are the disadvantages of a sole proprietorship?
- Personal liability—You can be held personally responsible for the monetary obligations held by the business.
Because a sole proprietorship is unincorporated, you are your business and your business is you. Or—more bluntly—if your business ever gets sued, so do you. If your business has debts, so do you. That can get expensive fast, especially if you ever face a catastrophe or any kind of liability lawsuit—which is why it’s especially important for sole proprietorships to have a Business Owner’s Policy (or general liability coverage, if a Business Owner’s Policy isn’t available in your state).
b. General Partnership
What’s a general partnership?
A general partnership is pretty close to a sole proprietorship—except for the fact that you will share ownership of the business with at least one other person.
What are the advantages of a general partnership?
- A general partnership is easy to get going. It could even start with a handshake, because no formal paperwork is required.
- Simple taxation—The tax situation is pretty straightforward (and very similar to a sole proprietorship). You and your business partners can each deduct your losses on your personal tax returns.
What are the disadvantages of a general partnership?
- Lack of control—Because you’re forming a company with other people, you won’t have as much say over what happens as you would if you were on your own—and a major disagreement with your partners could sink the whole business.
- Your liability risk—Since a general partnership works a lot like a sole proprietorship, you and your partners will each personally be responsible for the company’s debts and liabilities—that means you could end up paying for something unwise or negligent your partner did (so make sure you have liability coverage!).
c. Limited Partnership
What’s a limited partnership?
A limited partnership is a business structure in which at least one partner (often called a silent partner) isn’t involved in the day-to-day operations. For example, a silent partner might invest money in the company but wouldn’t have a big say in making decisions. (In other words, their partnership—and their responsibility—would be limited.)
What are the advantages of a limited partnership?
- You can limit your liability. Limited partnerships have many of the same advantages as general partnerships, but with one big difference: If you help form a company as a silent partner, you won’t have the same liability risk as full partners.
In general, you can’t be held liable for any amount greater than you contribute to the business. So if you put $10,000 into the business as a limited partner—and the company gets sued for $200,000—you likely wouldn’t be responsible for any more than $10,000 of that bill.
- A more durable partnership structure—A silent partner can leave the business at any time without dissolving the entire partnership.
What are the disadvantages of a limited partnership?
- More expensive—You’ll need to file paperwork with the state to form a limited partnership and there are generally fees associated.
- Liability might be unevenly distributed—If you organize your business as a limited partnership, the risks, responsibility, and liability won’t be evenly shared by all—only general partners are fully responsible for the company’s debts and obligations. (This isn’t necessarily a disadvantage, but it is a fact that should be clearly understood by every partner—you definitely want to make sure that everyone involved in your small business is clear about what their risks are.)
d. Corporation (also called a C-corporation)
What’s a corporation?
A corporation (or C-corporation) is a business that’s completely legally separate from its owner—in fact, it has a lot of the same rights that a person has. It can borrow money, start a lawsuit, own property, and enter a contract—as itself.
What are the advantages of a corporation?
- Less liability risk—The huge advantage of starting a corporation is the legal separation. Unlike a partnership or sole proprietorship, a corporation is legally responsible for itself—so if your corporation ever faces a major lawsuit, you won’t necessarily be personally liable for the financial settlement.
- Possible tax advantages—C-corporations are eligible for more tax deductions than other kinds of business structures—and the owners could also pay less on their self-employment taxes.
- Stock options—If you organize your business as a C-corp, you’ll be able to raise money by selling options.
What are the disadvantages of a corporation?
- It’s more difficult and expensive to start a corporation—and you’ll need to keep up with a bunch of paperwork and extra operating obligations.
- No deductions on your personal tax return—Since the government considers your business to be a completely separate entity, you won’t be able to claim losses on your personal tax filing.
- Double taxation—Your corporation’s profits could actually be taxed twice—one round of taxes on your profits, and another round on your dividends.
And that brings us to our next business ownership option.
What’s an S-corporation?
It’s a special kind of corporation that can help you avoid the double taxation problem. (FYI, the name is often shortened to “S-corp.”)
What are the advantages of an S-corporation?
- “Pass-through” taxation—If you want the personal liability protection of a corporation, but don’t want to get taxed twice, an S-Corporation is probably what you need. It allows business profits (and even some losses) to pass directly through to your personal income—no corporate tax.
- Liability protections—Like a C-corporation, an S-Corporation is responsible for its own liability—so there’s much less chance of you being personally liable for your business’ obligations.
What are the disadvantages of an S-corporation?
- More paperwork—Besides all the normal paperwork of starting and operating a corporation, you’ll need to go through a completely separate process to file for S-corp status.
- Expensive to start and maintain—All that paperwork requires lots of time and resources—you’ll probably need to pay someone to help you get everything started (and then stay on top of all the ongoing paperwork).
- Limited eligibility—Not every corporation can be an S-corporation—you’ll have to meet a set of strict requirements to qualify.
- Restrictions on selling stock—If you think selling stock is in your future, you’ll want to look at the law carefully—S-corps have more limits on issuing stock than C-corps do.
f. Limited liability company (LLC)
What’s a limited liability company?
A limited liability company (usually shortened to LLC) is a hugely popular small business structure which can help protect you—the business owner—from being personally liable for your business. An LLC combines elements of sole proprietorship, partnership, and corporation structures, and you can start one on your own or with other people (called LLC members).
What are the advantages of a limited liability company?
- Limits personal liability risk—An LLC can protect you personally from any business liabilities. It essentially draws a line between your business assets and your personal assets, so if your LLC ever gets sued, your personal property and personal banking accounts likely won’t be at risk.
- Tax flexibility—Like a sole proprietorship, an LLC allows you to pass profits and losses directly to your personal income. But if you’d prefer to pay taxes like a corporation, an LLC allows you to do that, too.
- Some paperwork and fees—LLCs aren’t as hard to get started and maintain as corporations, but you’ll still need to file official paperwork with the state to start one (and then pay any applicable fees).
g. Business Entities Summary
|Type of business entity||Limited liability protections?||Tax treatment||Government requirements level|
|Sole proprietorship||No||Taxed at personal tax rate||Low|
|General partnership||No||Taxed at personal tax rate||Low|
|Limited partnership||For limited partners only||General partners taxed at personal tax rate||Medium|
|C-corporation||Yes||Must pay corporate taxes(beware of double taxation on dividends though)||High|
|S-corporation||Yes||Taxed at personal tax rate||High|
|Limited liability company||Yes||Can choose how you want to be taxed||Medium|
2. How to choose a business structure for your small business
Now the big question: What is the best form of business ownership for small businesses? And—even more important—how should you organize your business? Well, it’s complicated. It depends a lot on how you want to manage your personal liability, how you want to be taxed, and how much control you want to have over the decision-making.
Here are the questions to ask yourself as you consider your business structure options.
How much ownership control do you want?
First, you’ll need to think about how much control you want over your business. Do you want to make all of the leadership decisions and operate solely by yourself? Or are you open to giving up some control if it means growing your business bigger (or getting more significant investment)?
If you want to operate your business completely by yourself, a sole proprietorship or LLC are your best options. On the other hand, if you plan to share control over your business, you can organize as a partnership, an LLC (with other members), or as a corporation.
How would you like to organize your business taxes?
The way you structure your business makes a huge difference in how you’ll do your taxes every year. Some structures offer pass-through taxation, which means you can claim profits and losses on your personal tax return, while other structures are taxed separately (which can result in double taxation).
If you don’t want to deal with possibly getting taxed twice, you’ll want to go with a sole proprietorship, general or limited partnership, or an S-corp. If you’re willing to sort out the double taxation issue—and you plan to grow your business big enough to reap the benefits—you can go with a regular C-corporation.
What about LLCs? They’re a bit more complicated, since you can choose whether to be taxed at the personal rate or at the corporate rate—in other words, they count as a pass-through option if that’s what you’d prefer, but you can also choose to have your business taxed separately if that arrangement saves you money. There are also some variations in LLC tax law by state. In general, though, LLCs are a great option for most small business owners, especially since they offer significant liability protection.
And that brings us to the next important question.
How do you want to manage your personal liability and risk?
When you form your business, you need to honestly ask yourself if you’re willing to put your personal assets and property on the line for your company. Some small business structures (such as sole proprietorships and partnerships) can leave you personally responsible for any financial losses your business suffers—even if that means you have to dip into your personal savings account or home equity.
Long story short: If you’re not willing to take that kind of bet, you should strongly consider forming an LLC (usually the best bet for small businesses) or a corporation.
How much time and money do you want to invest in your business structure?
Some kinds of business structures are easy to start—and others take a lot of time, effort, and paperwork. Sole proprietorships, for example, are the cheapest and easiest form of business to start. But if you want to start a corporation? You’ll need to invest significant time and money (and you’ll probably need to hire a lawyer).
How long do you want your business to last?
Finally, you’ll want to consider the future. Are you building a business that you want to exist apart from you? Do you want to pass your business to the next generation? Maybe you’re interested in selling it? Or is your business simply your project?
Here’s why we ask: Some business structures live easily outside of the person who started the business, and some don’t. For example, a sole proprietorship lasts as long as the owner is operating the business (or until the business is sold). If you choose to stop operating your business—that’s it. The sole proprietorship automatically terminates (unless you’ve made explicit legal provisions for passing it along).
If you own an LLC by yourself, the situation is largely the same. If you die or decide to stop operating the business without filing paperwork to transfer the business, the LLC will dissolve. (Although, in some states, your heir or legal representative will have the option to continue the LLC.)
A corporation business structure, on the other hand, has a life and legal rights of its own, and won’t automatically terminate if you stop participating in it. It can continue indefinitely—or at least until its shareholders voluntarily agree to dissolve it.
Okay, those are the major forms of business ownership—and a brief overview of what you should think about when choosing a business structure for your small business. Ultimately, your business structure depends on your larger goals: How big do you want your business to grow? How much risk are you really comfortable with? How do you want your business to fit into your life? What is the role of your business in your family and community?
Answer those questions and you’ll be well on your way to finding the best business structure for you.
Hey, we hope that was helpful. Remember: whichever small business organizational structure you choose, you can get peace of mind about your personal and business liability by getting liability insurance. (Get a 60-second estimate on liability insurance or a Business Owner’s Policy.)