What Is a Business? Types, Structures, and How to Choose the Right One

There are more than 36.2 million small businesses in the United States, making up 99.9% of all businesses. Whether you are thinking about starting your next side hustle or launching a tech startup, your goals and liability concerns will dictate your business type.

So, what is a business? By understanding different business structures and how they fit your goals, you can lay the foundation for your business’s future.

What Is a Business?

A business is an entity that provides goods and services to customers. While many businesses focus on earning a profit, nonprofit organizations exist for charitable or socially beneficial purposes. Businesses can range in size from solo freelancer to a multinational corporation.

Business vs. Company vs. Enterprise: What Is the Difference?

You’ll often hear terms like company, business, and enterprise thrown around casually in day-to-day conversations, but there are subtle distinctions between them. Business is the broadest term of the three, and it covers any type of organized commercial activity. When it comes to a company vs. a business, a company generally has a more formal legal structure, such as a limited liability company (LLC).

Meanwhile, an enterprise is a large-scale, complex business. Global corporations, such as Amazon and Ford Motor Company, are considered enterprises.

What Makes Something a Business?

What is a business? In general, an entity must fulfill three core requirements to be classified as a business.

1. A business must offer a product or service of value. 
2. The business must exchange the product or service for money or another form of compensation.
3. The business must have some level of internal organization.

What Is the Difference Between a Hobby and a Business?

Even an individual freelancer can meet the definition of being a business, but it’s also possible that the freelancer’s services are a hobby instead. If you are considered a business and not a hobby, it can impact your Internal Revenue Service (IRS) taxes, expense deductions, and tax form requirements. Under IRS guidelines on hobby and business classifications, freelancers must consider several questions.

• Does the taxpayer conduct the activity like a business?
• Has the activity been profitable in some years?
• Does the taxpayer adjust their operations to become more profitable?
• Is this activity the main source of the taxpayer’s income?
• Does the taxpayer possess expertise in the subject?
• Do the taxpayer’s motives focus on personal pleasure or financial gain?

Types of Businesses by Industry

One way to compare businesses is to look at their industry and the type of work they do.

Product-Based Businesses

This type of business focuses on producing, sourcing, and selling physical goods. To succeed, it must excel in inventory management, storefront creation (online or physical), and supply chain management. Because of the production facilities, equipment, and supplies required, product-based businesses often need more upfront capital than service-based businesses. Bakeries, e-commerce shops, and phone manufacturers are all examples of this type of business.

Service-Based Businesses

Rather than sell a product, service-based businesses sell intangible offerings, such as their labor, time, or expertise. For instance, law firms, plumbers, marketing consultants, and tutors are all service providers. While startup costs tend to be lower than those of product-based businesses, the capacity can be limited by the team’s capacity. Most businesses fall into this category. 

Retail and Distribution Businesses

Retail businesses buy from wholesalers and manufacturers in order to sell online or offline to consumers. Distribution businesses act as middlemen in the supply chain. To succeed, these businesses depend on their location, pricing strategy, and inventory management. Distributors, import businesses, and big box stores are common examples in this industry.

Technology and Software as a Service (SaaS) Businesses

Many tech and SaaS businesses are highly scalable, seek venture capital to grow quickly, have low marginal costs for additional products because they sell online. Often, SaaS companies rely on a subscription revenue model. Besides major tech leaders like Apple and Google, many small software firms and app developers make up this industry.

Hybrid Businesses

Many businesses straddle different industries. They may sell a blend of products and services, such as a gym that offers memberships and supplements. Similarly, IT companies can sell software licenses and support contracts. While operating a hybrid model helps to diversify revenue, it can also increase the complexity of the organization’s operations and its tax filing requirements.

Types of Business Structures: Legal Entities and Tax Elections

Beyond looking at what a business does, it’s also important to consider its structure. The business structure is how an entity is organized, taxed, and recognized by the government. Besides taxes, the type of business can also affect your liability and your options for raising capital. The right structure for your needs will depend on your overall goals, risk tolerance, and plans for future growth.

Sole Proprietorship

A sole proprietorship is the simplest business structure, but it carries significant risks. In this type of business, one person owns and operates it. As a pass-through business, all profits and losses are passed through to the owner’s tax return on their Schedule C.

While there are no formal registration requirements, owners may need to obtain local licenses and permits. Additionally, sole proprietorships have unlimited personal liability. If someone sues your business or your business defaults on a debt, your personal assets will also be at risk. Because of this, sole proprietorships are better suited for low-risk businesses or testing out a new idea.

Partnership

In a partnership, two or more people share ownership and responsibility. In a general partnership (GP), each partner is personally liable for the partnership's debts. Meanwhile, a limited partnership (LP) involves at least one general partner having full liability. Everyone else has limited liability capped at the amount of their investment. Like a sole proprietorship, profits from a partnership are passed through to each partner’s personal tax return. 

Often, this entity type is used when co-founders want to test out an idea or a professional group wants to create a business together. However, there are risks to using a partnership. Each general partner in the entity can be held responsible for the actions of other partners.

LLC 

An LLC is the most popular structure for small businesses in the United States. It offers liability protections and simplified taxation. Owners are generally not held personally liable for business debts or lawsuits, except in highly specific situations. When profits are earned, they can pass through to the owner’s personal tax return without requiring a corporate-level tax. They are popular among startups and small businesses because they are simple to form, offer flexible management options, and can be used with multiple owners.

C Corporation (C Corp)

A C corp is a separate legal entity, so it is taxed separately from its owners. C corps pay a federal corporate income tax of 21%. When dividends are paid, shareholders are taxed on them.

Although C corporations face double taxation, they also offer several benefits. These corporations can have unlimited shareholders from any country. Additionally, businesses need to incorporate as a C corporation if they plan to issue an initial public offering (IPO). Many investors and venture capitalists prefer investing in C corps because they have fewer shareholder limitations, easier exit strategies, and a broader range of stock options.

S Corporation (S Corp)

Unlike other business types on this list, an S corporation is not a separate entity type. It is a tax election that C corps and LLCs can take by filing Form 2553 with the IRS. Once the election is filed, all profits flow directly to shareholders’ or owners’ personal tax returns.

In exchange for the tax benefits, S corp owners face several important limitations. Shareholders must be United States citizens or residents. Additionally, S corporations may have up to 100 shareholders. They are also limited to just one class of stock.

In general, S corporations work best for small businesses. If you don’t plan on bringing in outside investors or foreign shareholders, an S corporation may be a good choice.

Nonprofit Organization

A nonprofit organization exists to serve a charitable, educational, religious, or social mission. The main difference between nonprofits and other businesses lies in how profits are distributed. Nonprofit organizations are allowed to earn a profit and generate revenue. However, any profits earned must be reinvested into the organization. 

With this entity type, founders and directors do not receive the organization’s profits. Instead, they can be paid a reasonable salary for the work they do for the nonprofit organization.

To be considered a nonprofit organization, the entity must meet specific IRS rules. They must file Form 1023 and meet the eligibility requirements to attain 501(c)(3) status. Once the nonprofit has 501(c)(3) status, they do not have to pay federal corporate income taxes. They may still be required to pay state, local, and payroll taxes, though some states exempt nonprofits from these taxes. It should also be noted that unrelated business taxable income (UBTI) remains taxable.

Benefit Corporation (B Corps)

A B Corp is a relatively new designation that can be a certification from the nonprofit B Lab or designation provided by the state. It is given to for-profit businesses that fulfill specific social, environmental, transparency, and accountability goals. 

It’s important to note that there is a difference between being labeled a benefit corporation and being certified as a B Corp. In most states, there are specific processes involved in becoming a benefit corporation. To be certified as a B Corp by B Lab, businesses must meet slightly different requirements and pay higher fees. 

Business Structure Comparison: A Side-by-Side Look

To get a better understanding of how these business structures work in practice, it helps to compare key differences side by side.

 

How To Choose the Right Business Type

There is no single business structure that is right for everyone. You must consider your organization’s unique goals, risk tolerance, and objectives. When in doubt, you can always use EntityCheck’s Secretary of State (SOS) Business Search to look up similar organizations in your industry to see how they are structured.

Consider Your Personal Liability Risk

What does your business do? Do you have many risks or a high level of debt? If your company is sued or cannot pay its debts, you need personal liability protection. An LLC or corporation status shields your personal assets, which is especially important in healthcare, construction, food service, and other high-risk industries. If you do business as a GP or sole proprietor, your personal assets may be at risk from business debts and lawsuits.

Review Your Tax Situation

Your business structure will directly impact how much you pay in taxes. With pass-through structures, such as LLCs, partnerships, sole proprietorships, and S corporations, the business income is taxed on the owner’s personal return. Meanwhile, C corps are taxed at the corporate level and again on the owner’s personal return if dividends are paid. However, personal income taxes can be reduced by reinvesting the C corp’s profits instead of distributing them.

If you are a pass-through entity, the qualified business income (QBI) deduction allows you to deduct up to 20%. Under recent legislation, this deduction was made permanent. In its new form, business owners receive a minimum deduction of $400, provided they have $1,000 in QBI.

Think About Your Funding and Investor Plans

If you want to reach international investors, go public through an IPO, or issue preferred stock, you’ll generally need a C corporation. However, many startups opt for simpler structures if they don’t plan on bringing in outside investors.

To see how other businesses in your industry are structured, check out EntityCheck’s SOS Business Search.

Look at Your Number of Owners and Partners

The number of current and future owners will also impact your decision. If you are a solo founder with no plans to bring in new partners, a sole proprietorship or a single-member LLC is likely the best choice. For multiple founders, a corporation or LLC will work best. Meanwhile, companies that want to attract multiple investors and shareholders should consider forming a corporation.

Evaluate Your Long-Term Growth Goals

Your long-term goals should guide your decision. If you want to stay small and local, an LLC or sole proprietorship may be all you need. For companies that want to scale quickly or go public, a C corporation is often a better route.

If you make the wrong choice early on, you can change your structure. However, switching from a sole proprietorship or an LLC to a corporation will require additional paperwork. By picking the right structure first, you can avoid the hassle of converting it later.

How To Register Your Business: First Steps

Once you have selected the right business type, you’ll need to take a few important steps to register your business. 

Step 1: Choose and Search Your Business Name

After selecting the right name, make sure it is available. You can search the Secretary of State’s database in your state to find out if the name is taken. EntityCheck’s SOS Business Search and Instant Doing Business As (DBA) Name Search make it easy to see if other organizations are already using the same name.

Step 2: File Your Formation Documents

If you are an LLC, you’ll need to file Articles of Organization with the Secretary of State in your state of formation. Corporations file Articles of Incorporation instead. 

Meanwhile, sole proprietors and general partnerships generally don’t have to file formation documents with their state. If you plan on operating under a business name, you may need to file a DBA registration.

Step 3: Get Your Employer Identification Number (EIN)

To hire workers or open most business bank accounts, you’ll need an EIN. An EIN is basically your business’s version of a Social Security number. LLCs and corporations are generally required to have one. Fortunately, it takes about 15 minutes to file for free on the IRS website. You can use EntityCheck’s Instant EIN Search to see if a business already has a registered EIN or to carry out due diligence on a vendor. 

Step 4: Obtain Required Licenses and Permits

Most businesses need permits and licenses to operate legally. If you are unsure about what is necessary for your industry or municipality, you can use EntityCheck to see what type of business licenses your competitors have.