Types of Business Entities

Sole proprietorships are the simplest and least expensive types of business entity. They are also the most common business structure where one person owns, controls, and runs the business themselves. Sole proprietorships are ideal for freelancers or small local businesses. There are distinct advantages to a sole proprietorship, including:

• Total control over all decisions
• Business assets
• And profit
• simplified taxes (utilizing pass-through taxation)
• Fewer regulatory requirements
• Ease of dissolution if needed in the future

Partnerships are businesses that have two or more owners who share the business responsibilities, profits, liabilities, debts, and legal obligations. These work well for doctors’ or dentists’ offices. Owners decide how the company will be managed. Partners may be hands-on and actively involved in the day-to-day operations or may opt for a silent investment role.

Types of Partnerships:

With general partnerships, all partners have unlimited liability, meaning they are personally responsible for the partnership’s obligations and debts. All partners are involved with running the business and making decisions.

With a limited partnership, some partners have limited liability, equal to their investment in the company.

Advantages of Partnerships:

Some pros of a partnership include shared resources and expertise, shared financial burden, pass-through taxation, shared decision-making, easier setup, and increased potential for attracting investors and new opportunities.

Disadvantages of Partnerships:

The cons with a partnership include unlimited liability, potential for conflict and disputes, shared profits, limited life, and difficulty transferring ownership.

LLCs are another very popular business entity type due to their limited liability protection and flexible tax options. LLCs work very well for small to mid-sized businesses, offering several significant benefits, but also have some drawbacks.

LLCs are quick and easy to set up and manage. Establishing or registering an LLC is inexpensive. The most significant benefit is the limited liability where owners are not personally liable for the business’s debts, obligations, or lawsuits.

Another important benefit is the pass-through taxation, where owners/members are taxed personally on the profits rather than the business being taxed as a separate entity. LLCs are flexible in that owners or managers can run operations, and they earn credibility as a type of corporation. LLCs can distribute profits any way they like, which is also beneficial. LLCs can choose to operate as C-Corps or S-Corps.

However, there are some drawbacks:

• Members are required to pay self-employment taxes, which can be substantial
• They may struggle to attract investors
• Ongoing fees such as annual report costs
• Strict record-keeping requirements, though still easier than traditional corporations
• Transferring ownership can be tricky

Corporations are separate entities that exist apart from their owners (shareholders), offering strong liability protection and perpetual existence along with other benefits. There are two primary types of corporations: C corporations and S corporations. Each is taxed differently.

Corporations can typically raise capital easily by selling stock, and they are generally highly respected as credible entities. You can transfer ownership easily through stock sales.

However, despite all the good news, there is some bad news. Establishing a corporation incurs significantly higher costs, including legal fees, registration fees, and ongoing expenses.

Drawbacks of corporations include:

• Double taxation — corporations pay taxes on profits, and owners are taxed on dividends
• Strict regulatory requirements and record-keeping
• Owner information is publicly available due to the public nature of the entity
• Subject to public scrutiny and reputational risks

Nonprofit corporations are business entities formed for charitable, religious, or educational purposes. They generally want to do good in the world and desire to make a positive impact. Many nonprofits are allowed tax exemptions on income and donations, which can be attractive to donors.

Owners typically have limited liability, protecting their personal assets from business activities and lawsuits. They may be eligible for grants and other types of non-standard revenue. They can also accept donations. The public generally trusts nonprofits, and they can foster a strong sense of community within their operating areas.

However, strict regulations may require that they reinvest the profits into the organization’s mission. Establishing a nonprofit can be a complex and expensive endeavor. Many nonprofits face funding challenges and cannot afford to pay high salaries, which makes it difficult for them to attract and retain top talent.

Challenges of running a nonprofit:

• Heavy reliance on donations, charity drives, and fundraising events
• Dependence on volunteers for essential operations
• Public scrutiny and the feeling that all actions are under a microscope

Co-ops are a unique business entity which are owned, operated, and managed by members who benefit from its services. Some examples include food co-ops, credit unions, and purchasing co-ops, such as Ace Hardware.

An interesting feature of co-ops is that every member (regardless of their investment in the business) has an equal vote on all decisions. The democratic voting process and equal share of profits make this an appealing entity to many.

Co-ops utilize pass-through taxation, which avoids double taxation, and may enjoy lower ongoing costs since employees are also owners. Members also receive limited liability protection.

However, co-ops face some challenges:

• More complex structure and governance
• Strict regulatory compliance
• Lack of flexibility compared to other entities

A trust, although not a typical business entity, is a legal arrangement in which assets are held and managed by one party for the benefit of another party or multiple parties. In business, trusts are often utilized for estate planning purposes. They are established to protect one’s assets from probate, lawsuits, or collections. They are also excellent for preserving privacy.

An owner can control the assets without direct involvement, allowing a “trustee” to manage and grow the wealth on their behalf. Many trusts help avoid taxes.

Some drawbacks of trusts include:

• Complex and costly to set up
• Limit your control over assets
• May result in legal disputes between beneficiaries

Licensed professionals working in the same field (such as doctors, dentists, lawyers, and realtors) can form a professional corporation and enjoy limited liability and tax benefits, including pass-through taxation. However, professional corporations are strictly regulated and not available in all states. The most essential requirement is that each owner be licensed in the same profession.

Social purpose corporations, also known as public benefit corporations, are a special type of corporation with a dual purpose: to make a profit while also advancing a social or environmental mission. Directors may receive legal protection for any decisions they make in their position. Owners benefit from limited liability protection.

These entities may enjoy a positive reputation and plenty of credibility due to their public benefit goals, but they must report on these regularly and are held to strict government standards. SPCs and PBCs are not available in all states, and they can be expensive to set up and maintain, have limited reach and funding results, which could result in lower profits. They also do not have any tax benefits.