Looking to start your own business? Congratulations! You’re onto something big – entrepreneurs like yourself are truly fueling the economy. To help you along, we’re here to explain the different types of businesses that you can choose from. So take notes, because this one is important to the foundation of your new business.
One of the first questions prospective business owners ask is, “What type of business should I form?” Indeed, the confusion surrounding this question often stops business ventures before they ever get started.
To clarify, there are seven basic types of businesses:
A sole proprietorship is one of the most popular business types, namely because it’s one of the simplest and only requires an individual. In a nutshell, a sole proprietorship is a business that’s owned by just one person. An important thing to note is that there isn’t a legal or financial distinction between the business and the business owner, which means that you as the business owner are fully accountable for all of the profits, liabilities and legal issues that your business may encounter. The nice thing about a sole proprietorship is that you don’t have to fill out any forms or go through any legal procedures to declare this type of business. Instead, just by owning a business on your own, a sole proprietorship is automatically associated with your new business. Keep in mind, however, that depending on your product or service (and your location), you may need to access a specific license or other documents.
Two heads are better than one, right? If that’s the philosophy behind your business structure, then a partnership might be the best choice for you. A partnership might be appropriate if your business is owned by two or more people. Keep in mind that with this type of business, business responsibilities, including financial and legal, fall upon each business owner. Depending on how the ownership is divided (either equally or not), there are different types of partnerships for you to explore from a legal standpoint. With that being said, a partnership does require that you register your business with your state and establish an official business name. After that, you’ll then be required to obtain a business license, along with any other documentation that your state office can help you with. Beyond that, you’ll also need to register your business with the IRS for tax purposes. Although this may seem like a complicated process, there are lots of benefits to a partnership, so if you’re looking to have a co-owner, don’t be afraid to go for it.
A limited partnership, or LP, is an off-shoot version of a general partnership, and while it may not be as common, it’s a great bet for businesses who are looking to raise capital from investors who aren’t interested in working the day to day aspects of your operations.With an LP, there are two sets of partners, one of which is known as a general partner. The general partner is usually involved in the everyday business decisions, and has personal liability. On the other hand, there’s also a limited partner (typically an investor), who are not liable for debts and don’t partake in regular business management of said company. Just like a general partnership, if you enter an LP agreement, you’ll need to register your business with the state, establish a business name, and inform the IRS of your new business. Again, this option is the most common for those looking for investment dollars, so keep that in mind when exploring your partnership options.
A corporation, is a fully independent business (when public) that’s made up of multiple shareholders who are provided with stock in a new business. Most common is what’s known as a “C Corporation,” which allows your business to deduct taxes much like an individual – the only problem with this is that your profits will be taxed twice, both at the corporate level and at the personal level. Don’t let this fact deter you however – this is extremely common, and if you currently work for a company with multiple employees, that’s likely the business structure they’re using. Most likely, if you’re starting off as a smaller business, particularly one that only operates online, declaring yourself as a corporation wouldn’t be appropriate. But if you truly are a corporation, you’ll need to file very specific documents with the state, followed by obtaining the appropriate business licenses and permits.
Limited Liability Company (LLC)
Next on our list is a Limited Liability Company, better known as an LLC. An LLC is a newer type of business that is a blend between a sole proprietorship and a corporation. Instead of shareholders, with LLCs, owners are referred to as members. No matter how many members a particular LLC has, there must be a managing member who takes care of the daily business operations. The main difference between an LLC and a corporation is that LLCs aren’t taxed as its own business entity. Instead, all profits and losses are moved from the business to the LLC members, who then, instead of having to report business finances on a corporate return, can report profits and losses on a personal federal tax return. The nice thing about pursuing an LLC is that members aren’t personally liable for business decisions or actions of the company in question, and there’s far less paperwork involved in creating an LLC as compared to a corporation.
A nonprofit organization is pretty self-explanatory, in that it’s a business organization that’s intended to promote educational or charitable purposes. The “non-profit” aspect comes into play in that any money earned by the company must be kept by the organization to pay for its expense, programs, etc. Keep in mind that there are several types of nonprofits available, many of which can receive “tax exempt” status. This process requires filing paperwork, including an application, with the government for them to recognize you as a nonprofit organization. Depending on the parameters of your new business, they’ll be able to tell you which category you best fall under.
The last on our list of seven popular types of business is what’s known a cooperative, or a business that’s fully owned and operated for the benefit of the members of the organization that use its services. In other words, whatever is earned by the cooperative is then shelled out among the members themselves, and aren’t required to be paid out to any external stakeholders, etc. Unlike other types of businesses, which have shareholders, cooperatives sell shares to cooperative “members,” who then have a say in the operations and direction of the cooperative itself. The main difference in the process of becoming a cooperative, as opposed to the other types of businesses listed, is that your organization must create bylaws, have a membership application and have a board of directors with a charter member meeting.
There are a number of good resources that outline and define them, such as this one.
To simplify your choice of business type, first ask yourself a few basic questions:
- Is your business a charity or is it for-profit?
- Is your business a partnership?
- Do you want to file the business taxes under your social security number, or do you want your business to have a Tax ID?
- How much personal liability are you comfortable with accepting?
- How much control will your partner (if you have one) assume?
- Will you have employees?
- Will your company be owned and operated democratically by its members with no single owner?
After you’ve answered these questions and have decided on a business type, the next steps are dependent on your state and local laws and ordinances, as you may need to fill out additional forms specific to your location and type of business. There are a number of books and resources for this. Many of them recommend using the Small Business Association as the starting point since they maintain local offices.
Finally, check your local and state laws regarding running a business out of your home, as zoning laws can sometimes be an important factor in your business decisions.
Starting a Business Part 1: Types Of Business
Starting a Business Part 2: Policies You Should Think About
Starting a Business Part 3: Choosing The Right Products To Sell
Starting a Business Part 4: Selecting A Dropshipper
Starting a Business Part 5: Logo Design
Starting a Business Part 6: How To Get Paid
Starting a Business Part 7: Marketing your Business