When you started the process of launching your business, you likely gravitated to items on the checklist that sparked your creativity, such as perfecting a sales pitch or creating a business website. Other to-dos are less obvious and less enticing to complete, but just as important—sometimes even more so.
In fact, one of those behind-the-scenes tasks is so important, it’s the very first step to take once you begin the launch phase: determining what type of business structure to use to start a business.
This decision will affect nearly every aspect of your operation. Although it’s tempting to consider the selection a mere formality, it’s important to thoroughly research your options so that your venture is positioned for success. In this article, we’ll explore:
Why does your business type matter?
Your business type (a.k.a. “business structure” or “business entity”) is the legal blueprint for creating and running a business. Your chosen business structure determines company ownership, profit distribution, decision-making power, regulatory requirements and taxation.
Beyond these high-level parameters, the structure of your business affects many aspects of day-to-day operations, such as administrative overhead, record-keeping and tax planning. Banks and investors may look at your business structure when deciding whether to give you a loan or other financing. And if your company runs into legal or financial trouble, your business structure determines who’s responsible.
In short, the type of business structure that you choose impacts the organizational structure of your company at every level. Therefore, it’s crucial that you think carefully about this decision and ask your financial advisor, attorney or accountant to weigh in. Professional associations, local chambers of commerce, networking contacts and business mentors can also provide guidance on the matter if you can’t afford to hire someone at the moment.
Although you can convert your business from one entity type to another if circumstances change, the process to do so can be costly and time-consuming. It’s therefore better to launch your business with a structure that will accommodate all the growth and change you can foresee.
12 types of business structures
The four most common types of business structures are sole proprietorships, partnerships, corporations and LLCs. However, there are sub-categories within these classifications, as well as other types of businesses to consider.
Each type of entity has its own advantages and disadvantages, especially in regards to accounting, taxes and liability. In this section, we’ll provide a detailed overview of each of the following types of businesses:
01. Sole proprietorships
A sole proprietorship is the simplest and most affordable business structure because it involves fewer legal formalities. Basically, all you need to do to start a sole proprietorship is to start doing business. Keep in mind that although the federal government doesn’t require sole proprietorships to take extra steps, your state or local government might.
Sole proprietorships are pass-through entities, which means business owners claim profits on their personal tax returns. As a result, accounting and tax reporting are relatively straightforward and business owners only need to pay one set of taxes.
On the flip side, sole proprietorships can be a risky option because legally, the owner bears complete responsibility for the activities of the business. So, if your sole proprietorship runs into legal or financial problems, your personal assets (such as your home and personal savings) could be at risk.
That said, a sole proprietorship is likely a safe bet if your business doesn’t involve significant startup or operational costs and you don’t plan to involve other people in the business. This business structure is generally appropriate for freelancers, online store owners, personal trainers and consultants.
If you want to start a side hustle or aren’t sure if your venture will be a full-time thing, you may consider starting as a sole proprietor. You can always change your business structure down the road if your company expands. For example, Pierre Omidyar started eBay as a sole proprietorship in 1995 and incorporated it seven months later.
02. Limited-liability companies (LLCs)
An LLC is one of the most flexible options for structuring your business. This type of business combines the liability protections of corporations with the pass-through tax benefits and flexibility of a sole proprietorship.
LLCs don’t offer stocks for employees or outside investors. Instead, they offer membership to individuals with an ownership stake. Members can manage day-to-day business operations of an LLC themselves, or they can function more like a corporate board of directors overseeing the activities of non-member company directors and officers. Because there’s more opportunity to commingle member and employee roles, those involved in LLCs are exposed to more personal liability than those in corporations.
The types of businesses that use the LLC structure vary from single-person businesses to massive companies. Forbes, Deloitte and Kind are just a few prominent examples of LLCs.
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Partnerships
As the name implies, a partnership enables two or more people to start a business together. Forming a partnership is a simple way to share the responsibilities and rewards that come with owning a company.
As with a sole proprietorship, a partnership doesn’t require you to set up a separate legal entity, which makes it easier and less expensive to get started. Also like sole proprietorships, partnerships are pass-through entities; profits are simply distributed directly to individual partners and taxed as personal income.
Partnerships aren’t one-size-fits all—there are three different types and each has different characteristics, advantages and disadvantages. Whichever form your business takes, it’s wise to create a partnership agreement that clearly outlines roles, responsibilities and profit-sharing formulas.
03. General partnership (GP)
If you plan to run a business as a true partnership in which you share the responsibilities, gains and risks evenly with your partners, a general partnership is right for you. Each partner has an equal say in legal decisions and daily operations.
That equality extends to liability. All partners bear equal responsibility for debts and legal problems, even if one single partner is the direct cause. If a partner leaves, the entire enterprise could dissolve.
Professional service companies with two or more founders, such as architectural firms or ad agencies, are often a good fit for general partnerships. Companies that require pooled startup capital to launch, such as restaurants or art galleries, also tend to form GPs.
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04. Limited partnerships (LP)
A limited partnership involves a general partner who typically runs the business and assumes all liability as well as a limited partner (a.k.a. a “silent partner”) who contributes capital but doesn’t participate in day-to-day operations. Silent partners typically earn a proportional share of profits and their liability is limited to their initial investment in the company.
Because LPs are easy to set up and dissolve, they are especially useful for short-term projects that require significant investment. For instance, film productions often operate as LPs in which the studio is the general partner and the investors are silent partners. The LP business structure can also be useful for real estate projects, private equity firms and small businesses that require significant investment.
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05. Limited liability partnership (LLP)
In an LLP, each partner has limited liability for the company’s impact and activities, even if they have an active role in managing the business. Each partner benefits from a simple profit-sharing plan, while enjoying protection from debts and liabilities held by the company as a whole.
Rules for forming an LLP vary from state to state. In some locations, only specific professions requiring licensure can form LLPs, such as doctors, accountants and financial advisors. LLPs enable professionals to share overhead costs and profits, without being subject to malpractice claims levied against another individual in the group.
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Corporations
If you form a corporation, your company exists apart from you. It is a separate entity with its own governance, taxation and liability. Because individuals can’t be held personally responsible for a corporation’s impacts, actions or debts, the structure significantly reduces the potential risk for owners and investors.
The tradeoff for this protection is complexity. There are more record-keeping requirements and regulations governing corporations than other types of business. Corporations involve a significant amount of administrative overhead, regardless of the company’s size and corporation type.
06. C corporation (C corp)
A C corporation is the type of company you likely associate with the word “corporation.” It’s a legally constructed entity that has a board of directors who are responsible for guiding business decisions. C corps are subject to corporate income tax on profits, meaning that the company is taxed as an individual entity and its individual employees and shareholders are taxed on their personal income.
If you want your company to go public and sell shares on a stock exchange, then a C corp is the way to go. Many publicly traded household names like Apple or Target are organized as C corps. C corps can also issue stocks without being publicly traded in order to raise capital for large initiatives.
C corps are generally more complex to set up and manage than partnerships or sole proprietorships, but it’s much easier to transfer responsibility and ownership. The administrative burden may be worthwhile for companies with potential to grow quickly and scale globally right away.
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07. S corporation (S corp)
An S corporation is something of a hybrid business type. S corps are separate legal entities, with all the structure and governance that C corps entail. But like sole proprietorships and partnerships, S corps are pass-through entities, enabling shareholders to claim business profits on their personal income taxes. As a result, S corps largely avoid the double taxation that C corps face.
Companies must meet specific criteria to qualify as S corps. Among them:
S corps can only have up to 100 shareholders. This makes it more difficult to raise capital through the sale of stock than C corps.
Shareholders of an S corp must reside in the U.S.
S corps can have only one class of stock, with every shareholder receiving the same voting rights and access to dividends. By contrast, C corps can offer different classes of stock that give preferential treatment to some shareholders’ votes and offer different dividend benefits.
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08. Close corporation (CC)
Because they aren’t publicly traded, close corporations (a.k.a. “privately held companies” or “family corporations”) operate under looser governance and reporting rules than other corporations, giving shareholders flexibility and control akin to a partnership. Shareholders are limited in number and are typically family members, employees and others directly involved in the company. This structure allows shareholders to have greater control and flexibility in managing the company, similar to a partnership.
While this format is typically associated with smaller businesses, close corporations are also well-suited to larger companies that need the structure of a corporation while maintaining family or private ownership. The Publix supermarket chain and Kohler manufacturing company are examples of large privately-held corporations.
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09. Public benefit corporation (PBC)
A public benefit corporation designation is supplemental to a company’s primary business structure and doesn’t affect its federal tax status. Depending on where they’re located, C corps, S corps, CCs and co-ops can qualify for PBC status.
Also known as “benefit corporations,” PBCs publicly commit to balancing the pursuit of profit with acting in the best interests of society and the environment. Keep in mind that this business structure is distinct from the Certified B Corp credential, which is a separate designation that companies can get from the nonprofit organization, B Lab. Therefore, your company can be a benefit corporation without being a Certified B Corp.
For example, Warby Parker is a C corp with a PBC designation and a B Corp certification. That means that it is a publicly traded company that prioritizes social and environmental objectives over shareholder profits. Its B Corp status means that B Lab has verified that it meets its standards of social and environmental impact.
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10. Nonprofit corporation
Nonprofit corporations are technically considered corporations because they are required to file articles of incorporation with the state that they're registering in. But in almost every other respect, non-profits have little in common with the average company.
Even compared with a B corp, nonprofits have a very different structure and purpose. A B corp can still earn a profit and pay its shareholders, whereas nonprofits don’t have shareholders and don’t have to pay dividends. Instead, proceeds are reinvested in the organization.
Organizations must satisfy a number of criteria to earn nonprofit status. But once established, nonprofits are exempt from paying federal income taxes and eligible to seek grants and other donations.
Well-known nonprofits include the Sierra Club and Habitat for Humanity. Likewise, local cultural institutions, churches and charities are almost always organized as nonprofit entities.
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11. Cooperative
Like nonprofits, cooperatives (a.k.a. “co-ops”) are technically corporations, but they have unique characteristics that set them apart. A cooperative is owned by its customers, its employees or both. There are no shareholders nor stocks. Like an S corp or a partnership, profits are taxed solely as personal income.
Crucially, no owner has a disproportionate ownership stake. Whereas executives of a traditional corporation might hold more shares than a front-line worker each member of a cooperative has equal say. Employee-owners are deeply invested in the success of the company and are often additionally motivated by socially conscious business goals.
Because of that arrangement, decision-making within a co-op can be slow, and reaching consensus can be challenging. Traditional funding sources like bank loans and venture capital may be harder to come by, so co-ops may encounter cash-flow issues as they grow.
Outdoor retailer REI is one of the most famous examples of a consumer cooperative, with customers paying a one-time membership fee to access annual dividends. One of the largest worker-owned co-ops, Cooperative Home Care Associates, provides home health care in the New York City area.
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12. Joint ventures
If you’re joining forces with other businesses to collaborate on a specific project or task, you can make your partnership official with a joint venture arrangement. Formalizing the relationship ensures that your business retains its independence while benefiting from the resources of other participants. Joint ventures can help you and your partners move more quickly on urgent initiatives than if you were to handle them alone.
It’s critical to plan beforehand to ensure that roles and responsibilities are clear. Negotiate your share of the costs and liability for the project, and spell out a clear exit strategy in advance. Otherwise, if the project stalls or falls apart, you may find it difficult to end the venture without significant legal costs.
Any type of company can be involved in a joint venture: C corps can partner with nonprofits on a charitable initiative, for example, and an LLC can establish a joint venture with a partnership. A C corp can also do the same with a nonprofit. For example, when the global pandemic began in 2020, diagnostic testing firm Renalytix AI formed a joint venture with Mount Sinai Health System called Kantaro Biosciences to develop COVID antibody test kits.
How to decide which type of business structure is right for you
To set up your business for long-term success and avoid future legal or financial issues, it's important to weigh the pros and cons of each business structure. Consider your business's unique attributes and goals, and research which structure aligns best with your vision. Specific considerations include:
Startup costs, complexity and speed
Establishing each type of business requires a different level of investment. For example, establishing a corporation or LLC requires paperwork to get started, whereas you can file your taxes as a sole proprietor without even registering your business in many states.
Tax implications
The type of business you establish will have significant implications for your taxes. While requirements vary at the state and local level, these general tax categories apply:
Pass-through tax status: Sole proprietorships, partnerships, S corps, LLCs and co-ops have pass-through status. As noted above, that means business owners claim the business’s profits on their personal tax returns.
Double taxation: Double taxation occurs when a company’s profits are taxed at both the corporate and personal levels. C corps are taxed as independent entities, while their shareholders and employees are additionally taxed on their personal income. Closed corporations, B corps and cooperatives are subject to corporate tax unless they also file for S corp status.
Tax exempt: Nonprofit organizations are exempt from taxation, but their employees are still obligated to pay income taxes..
For complete, up-to-date information about the tax implications of your business structure, refer to the IRS website.
Liability
Your exposure to risk is a key consideration when deciding what type of business to establish. Selecting a business entity that shields your personal assets is wise if you’re entering a volatile marketplace, expect margins to be thin, need major capital investment or provide professional services subject to malpractice claims.
Fundraising
Some types of businesses allow other individuals or institutions to invest in your business as partners or shareholders, while others do not. If you already have other stakeholders on board, or plan to add them in the future, you’ll need a business structure that accommodates their involvement.
Additionally, if you plan to seek funding from banks and business lenders, they may require you to establish a more formal business structure than a sole proprietorship or partnership. Similarly, proof of nonprofit status is often a requirement for mission-based organizations that seek grants and major donations.
Purpose vs. profit
If your business or organization has a mission beyond generating revenue, you may decide to establish a structure that formalizes those priorities. By design, B corps and co-ops must balance profit-making with social and environmental goals. Purpose-driven entities may qualify for targeted investment opportunities, grants and government programs.
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