Which Business Structure is Right for You?

A lot of people want to work for themselves.

That’s one of the conclusions of the September 2023 report The Global Entrepreneurship Monitor, an annual study by Babson College. They found that 19% of adults—nearly one in five—have founded a business in the past three and a half years, or in the process of founding one. That is the highest level since The Monitor started its reporting in 1999.[1]

Within our firm, we have noticed an uptick post-pandemic in the number of informational requests we receive from small business owners who are just starting out. A great many of their issues seem to arise from a lack of clarity around what business structure they should have chosen—and in some cases, buyers’ regret over the path they did follow.

The decision comes down to some basic questions, as presented by Upflip[2]:

  • Do you want to keep your personal and business finances separate?
  • What are your tax priorities?
  • Will there be more than one business owner?
  • Do you plan on hiring employees?
  • Are you starting the business to make a profit or to help people?

There are a number of online interactive quizzes that purport to help you make the decision, but each appears to be promoted with a certain answer in mind, based on the business offering the quiz. To simplify matters, here are the pros and cons of each type of entity:

Sole Proprietorship

A sole proprietorship is an unincorporated business, with a single owner who pays personal income tax on any profits from the business. It is often operated under the owner’s name rather than a fictitious name, simply because at this level a business name isn’t necessary.

Pros of a Sole Proprietorship

  • This is an easy set-up. There is no extra paperwork to start, other than business licenses for your municipality, county, and state in order to operate legally.
  • You might need to file for a DBA (Doing Business As) if your business is other than your name. For example, Jackie Miller might wish to have her bank accounts and paperwork listed as “Jackie Miller DBA Miller’s Home Design.”
  • There’s only one owner—meaning you get to have it your way almost all of the time.
  • You are taxed only once, and there is no separate tax return required. It all goes on your personal taxes.

Cons of a Sole Proprietorship

  • There is no personal liability protection. You are responsible for all taxes, all loans, all accidents. If something goes wrong, you can be sued for everything you own.
  • You must pay self-employment tax on all earnings.
  • As you cannot sell stock, it’s more difficult to raise money.
  • You are not eligible for business loans or grants.
  • There is a perception that this is not a “valid” business structure.

LLC – Limited Liability Company

A hybrid between a sole proprietorship and an S-Corp, an LLC protects its owners to some extent from personal responsibility for debts and liabilities incurred by the company and offers a high level of flexibility. Owners are referred to as “members” of the company.

Pros of an LLC

  • There is no requirement for a board of directors to exist.
  • There can be an unlimited number of members (owners) for the company, providing funding opportunities.
  • You are not personally responsible for the business liabilities. (But see the Cons.)
  • You can choose whether to declare revenue on your personal tax returns or with a separate filing, whichever will work to your best advantage.

Cons of an LLC

  • There are ongoing filings and fees required to stay in compliance with local, state, and federal laws.
  • LLCs cannot become publicly traded companies.
  • They aren’t recognized outside of the US, so you might be taxed as a corporation in other countries.
  • Members of the LLC must pay self-employment taxes.
  • In some states, if one member chooses to leave the company, the LLC must be dissolved.
  • There are some situations where the members are held personally liable for business debts: if they personally guaranteed the debt, or if a court determines that they are personally liable.

S Corporation

An S Corporation is a business structure where the company passes its corporate income, losses, deductions, and credits through to their shareholders for tax purposes, as opposed to filing a company tax return. The company is owned by shareholders, and not by an individual.

Pros of an S Corporation

  • You are not personally responsible for business liabilities.
  • You are only taxed once; shareholders pay only on profits that they receive, on their personal tax returns.
  • The owners get common stock, which comes with voting rights as to the company’s direction.
  • This is considered a sound risk for investors.
  • Transferring ownership is easier, whether through a merger or a sale.

Cons of an S Corporation

  • There can only be a maximum of 100 shareholders.
  • Owners can only get common stock.
  • There are ongoing fees and filings required to stay in compliance.
  • A board of directors is required, leading to less management flexibility.
  • There are strict regulations around holding meetings and keeping records.
  • All shareholders must be citizens or residents of the United States.
  • Shareholders can only include trusts, estates, and individuals.

C Corporation

A C corporation, like the S-Corp, is owned by its shareholders. The main difference is that with a C-Corp, the company is taxed separately from its owners, filing its own return each fiscal year. This is the best plan should you intend to take your company public one day, as it allows you to issue shares to the founders, to employees, and to investors.

Pros of a C Corporation

  • There can be an unlimited number of shareholders.
  • Owners get “preferred stock,” giving them priority on dividends before common stockholders.
  • C-corps are recognized internationally as a legal business entity.
  • Owners are not personally responsible for business liabilities.
  • They are highly attractive to investors.
  • Because profits and losses are split between the shareholders and the business entity, it results in a lower tax rate for both.
  • If a shareholder leaves or dies, the company remains in business.

Cons of a C Corporation

  • Technically C-corps are taxed twice: the business files a corporate tax return, and the shareholders must declare their income on dividends.
  • A board of directors is required, meaning the founder has less flexibility with management.
  • There are laws about meetings and record-keeping which don’t exist with smaller structures.
  • Frequent filings and fees exist to stay in compliance with government legal requirements; in fact this is the most costly type of corporation.

Nonprofit

A nonprofit is a business to which the IRS has granted a tax exemption, because the company provides for the public good and furthers a social cause. Contrary to common understanding, this does not mean that the company cannot turn a profit; it simply means that the profit is reinvested for the furthering the company’s mission of doing good.

Pros of a Nonprofit

  • A nonprofit looks more credible to potential donors.
  • You have access to a number of grants, both public and private.
  • You are not personally responsible for business liabilities.
  • You are tax exempt if you have 501(c)(3) status with the IRS.
  • Charitable contributions are tax deductible for the donors.

Cons of a Nonprofit

  • You technically cannot own a nonprofit; you can only oversee it.
  • The fees for starting a 501(c)(3) are higher than for other business structures.
  • There are ongoing fees and filings required to stay in compliance with laws.
  • You must have a board of directors.
  • There are strict regulations about frequency of meetings and record-keeping.
  • The economy and the government administration play a large role in the availability of donations and funding.
  • In most cases, founders and employees see little to no profit and work for less money.

Conclusions

So, which is the right structure for you? That’s something that you need to decide, ideally with a business advisor or an accountant. Going into business for yourself is an admirable venture; the trick is setting it up correctly from the start to get you where you want to go. If you’d like to discuss your goals further, please feel free to reach out to us for a consultation.


[1] Bhattarai, A. (n.d.). American entrepreneurship is on the rise – The Washington Post. https://www.washingtonpost.com/business/2023/09/14/small-business-entrepreneurship-gem-report/

[2] Boushy      2 years ago      Learn          0, B. (2022, December 1). 11 types of business structures: Which one’s the best fit? Start, Build & Grow Your Business with UpFlip. https://www.upflip.com/learn/types-of-businesses

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