Understanding the Different Types of Business
When seeking to start a business, individuals should first decide which type of business structure they are interested in developing. While each different structure has its own idiosyncrasies, the basic differences between the various business structures relates to legalities and income tax return. Thus, each type of business has its own tax and legal protocol.
While new business segments are in development, the most common types of businesses are sole proprietorship, partnership, corporation, S corporation, and the relatively new Limited Liability Company (LLC).
A sole proprietorship refers to an unincorporated business that is owned by a sole individual. A sole proprietorship is the most common and simple of business structures, as there is no difference between the business and you.
One of the main reasons that sole proprietorships are so common is that their formation requires no formal action. Thus, many individuals function as sole proprietors without even knowing it (e.g. freelance graphic artists).
Benefits of a Sole Proprietorship:
• Cheap to form
• Absolute control
• Simple tax procedures
Disadvantages of a Sole Proprietorship:
• Unlimited personal liability
• Difficulties with generating money
• Major responsibility
Partnerships refer to a sole business owned by two or more individuals. Typically, each owner has equivalent contribution to business operations (e.g. finances, rent, decision making, etc.), as well as equal responsibility for financial success or failure.
There are generally three different types of business partnerships:
General Partnerships are founded upon the premise that duties and responsibilities will be equally divided amongst owners. If any owner wants more or less, then documentation must be complete and signed in agreement by all partners.
Limited Partnerships are more complex than general partnerships, as they provide partners with the opportunity to opt out of a majority of management decisions. Partners choosing to limit their managerial decisions provides them with limited liability as well. As a whole, these limits coincide with each owner’s percent of investment, which makes limited partnerships intriguing to those that are more interested in short-term enterprises
Joint Ventures are similar in function to general partnerships, but differ in that they are designed more for single or time-sensitive projects. Partners partaking in joint ventures have the opportunity to continue beyond the designated time-frame, but must fill out paper work to do so.
Benefits of a Partnership:
• Relatively cheap and simple
• Shared financial burden
• Incentives for employees
Disadvantages of a Partnership
• Joint and individual liability
• Potential for disagreements amongst owners
• Shared financial gains
Despite the term being a common amongst the general public, few people actually understand what a corporation actually means. Generally speaking, corporations refer to a sole self-sufficient legal entity that is owned entirely by its shareholders. Thus, it is the corporation itself that is responsible for its actions and debts, not its workers or the shareholders. Corporations are well known to be more intricate than other business structures, predominately due to their legal structure and tax requirements.
Benefits of a Corporation:
• Limited liability
• Ease of generating funds
• Special corporate tax treatment
• Intriguing to high-quality employees
Disadvantages of a Corporation:
• Complex tax requirements
• A multitude of paperwork
An S Corporation is a particular corporation created via an IRS tax ballot (thus, you can think of the “S” as referring to a “Special Corporation”). S Corporations are extremely appealing to businesses that are currently filed as corporations, for S Corporations do not have to pay the double taxation placed upon regular corporations.
Benefits of an S Corporation:
• Tax benefits
• Tax savings
• Tax credits
Disadvantages of an S Corporation:
• Strict operations
• Requirements relating to compensating shareholders
• Limitations on number and types of shareholders
Limited Liability Company (LLC)
Limited Liability Companies can be best described as an amalgamation of the limited liability features of a corporation and the efficient, flexible nature of a partnership. It is important to note, though, that LLCs are taxed much differently than single-entity method of corporations. Instead, the financial gains and losses and losses overpass the company and are thus divided amongst its members.
Benefits of an LLC:
• Profit sharing
• Simple operational procedures
As noted, the major differences between business types typically refer to financial liability and operational responsibility. If an individual is seeking primary responsibility, they would be wise in starting a sole proprietorship or partnering with someone who compliments their skill set. If shareholders are interested in having their company become a single entity or limiting overall liability they would be wise in exploring the more intricate business structures.
Rutgers Bachelor of Arts in Business Administration online gives students the advantage of accessing real-world knowledge from distinguished educators and top researchers in the field business. Graduates of the Rutgers B.A.B.A. program will be equipped with the skills and experience necessary to compete in the business world and stand out among their peers.
This post was created thanks to the help of Dr. David Pedersen, Assistant Professor at Rutgers University. Dr. Pedersen’s research focuses on mergers and acquisitions, institutional investors, and activist investors. He has been published in journals such as the Journal of Corporate Finance and Journal of Empirical Legal Studies.