Business structure, or business management structure, is a term used to describe the way in which a business is organized in terms of leadership, direction, and rights/liability. Additionally, how you structure your business can determine the following factors:
- The amount of business taxes that you are required to pay;
- The amount of personal liability that you will have; and
- The amount of paperwork that is required to establish and maintain your business.
Some of the factors to consider when choosing a business structure include:
- The potential risks and liabilities that are inherent to the business;
- The type of costs that will be incurred in order to establish and maintain the business structure;
- Potential required investments; and
- How both federal and state governments will tax the business.
Some of the most common business structures include:
- Sole Proprietorships: A sole proprietorship has only one owner, and does not need to be registered with the state where the business is located. These types of businesses are considerably easy to set up and maintain. The owner of the sole proprietorship makes all of the management decisions for the business; and, all profits and liabilities of the business belong solely to the sole proprietor. While simple and easy to maintain, this structure still requires the owner to ensure that the business stays legitimate by keeping up to date with local registration, business licenses, and other permit laws. The biggest disadvantage to a sole proprietorship would be that the owner has no protection if they are sued or have liabilities;
- Partnerships: Partnerships, or general partnerships, do not require any legal formalities in order to be formed. A general partnership is defined as two or more people engaged in a business for profit. These partners agree to share the profits and financial losses of the partnership; additionally, each partner is individually liable for the business debts of the partnership if the business itself cannot pay the bills. If a contract, tort, or criminal liability suit is brought against one partner, it is brought against all the other partners as well. Under a general partnership, all partners are considered to be agents for the other.
- As such, partners have a fiduciary duty to act in the best interest of the partnership. If a partner breaches this fiduciary duty, the other partner(s) can sue the breaching party for damages resulting from that breach;
- Limited Partnership: A limited partnership exists when there are one or more general partners, as well as one or more limited partners within a partnership. In a limited partnership, one partner must be the general partner who makes the management decisions of the business, while the limited partners do not. However, the general partner also assumes 100% of the risk for all of the liabilities and debts of the limited partnership. Limited partners only risk the financial contributions they originally made to the limited partnership. However, all of the partners in a limited partnership share in the profits of the business;
- Limited Liability Partnerships (“LLP”): A Limited Liability Partnership, or LLP, is a partnership in which one or all partners have limited liability for the partnership. An LLP is unusual in that it exhibits the elements of both a partnership and a corporation. A defining characteristic of an LLP would be that one partner is not responsible or liable for another partner’s misconduct and/or negligence;
- Corporations: A corporation is a legal entity that is owned by shareholders within the corporation. The corporation itself, and not the shareholders, are legally liable for the actions and debts that the corporation incurs. Additionally, a corporation enjoys most of the rights and responsibilities that an individual possesses. Specifically, the corporation may enter into contracts, loan and borrow money, sue and be sued, hire employees, own assets, and pay taxes. There are four different types of corporations: C Corporations, S Corporations, Professional, and Nonprofit Corporations; and/or
- Limited Liability Companies (“LLC”): Limited liability companies share the limited liability of a corporation, but are not held to the same strict management requirements of a corporation. Additionally, a person can only create an LLC by following the state laws in which the LLC is formed. An LLC is generally defined as a business entity that exists somewhere between a corporation, and a partnership that consists of one or more persons. Something else to consider is that an LLC combines the pass-through taxation of a partnership with the limited liability of a corporation. An LLC has managers, members, and sometimes employees.
- Additionally, the owners or members of a LLC participate in the management of the business. Members, managers, and employees are not held personally liable for the debts of the business, as they would be in either a general partnership or sole proprietorship.