What are the Types Of Businesses
WHAT TYPE OF BUSINESS
- Sole Proprietorship
- S and C Corp
- Nonprofit 501C
How to choose the right business entity
Choosing the right business entity allows an entrepreneur to reduce liability exposure, minimize taxes, and ensure that the business can be financed and run efficiently. It also provides business owners with a mechanism for ensuring that the business operations will continue, rather than being automatically terminated, upon the death of an owner. Formalizing the business also clarifies the ownership of all participants in the venture.
When choosing a business entity, you should consider: (1) the degree to which your personal assets are at risk from liabilities arising from your business; (2) how to best pursue tax advantages and avoid multiple layers of taxation; (3) the ability to attract potential investors; (4) the ability to offer ownership interests to key employees; and (5) the costs of operating and maintaining the business entity.
Despite the implication in this article’s title, you should not approach this subject with the idea that there is only one entity type that’s right for your business. The choice you make will inevitably involve weighing the advantages and the disadvantages of several factors that apply to your particular business. You should also keep in mind that there will inevitably be various changes in the nature of your business over time, and these changes may make it more advantageous either to change your entity type or its tax classification. With that in mind, let’s take a look at the main entity types that are available.
The availability of a particular entity type initially depends on the number of owners. A single owner may operate as a sole proprietor, a corporation, or a limited liability company. If there are two or more owners of the business, by definition it cannot be a sole proprietorship, but it can be a corporation, limited liability company, general partnership, limited partnership, or, in certain situations, a limited liability partnership
Final Thoughts on Choosing the Proper Business Type
The initial choice of an entity will usually come down to answering three basic questions:
- Who will be the business owners?
- How does the business expect to distribute profits to its owners?
- Is the business expected to generate profit or losses in the early stages?
Ownership of the Business
If the business is owned by one individual who does not expect to add ownership interests, then the management structure and flexibility is not of particular concern and any of the above business entities other than partnerships may be appropriate. The owner’s decision will depend more on tax considerations and personal liability protection.
Distribution of Profits or Keeping Cash in the Business
If the objective of the owners is to distribute the profits of the business each year, they will want an entity type that allows for “pass-through” taxation. On the other hand, if the owners intend to expand the business, use profits to purchase equipment, additional raw materials, or accumulate cash for future business purposes, a C Corporation may be the best choice.
If it’s anticipated that the business will have operating losses in its first year or two, the owners may prefer an entity that allows “pass-through” taxation so that losses may be used to offset income from other sources.