Types of Companies & Business Structures for Entrepreneurs & Small Business Owners
Entrepreneurs and small business owners are commonly held in high regard in America. According to key findings published in the Global Entrepreneurship Monitor United States Report 2017, “75% believe that entrepreneurs receive high status in society, a higher figure than the average of the 23 innovation-driven economies.” Additionally, the report noted that a majority of Americans believed there were numerous opportunities to start a business where they live, and that entrepreneurship overall is a good career choice.
Aspiring entrepreneurs may be wondering what type of company or organization may best suit them. Some entrepreneurs may wish to be the sole employee or key officer within their organization, and as such, there is likely a type of business structure that would be more beneficial to them. Others may have plans for ambitious growth. In this case, another type of business organization may be more beneficial; one where they may need to hire dozens, potentially hundreds, of employees.
Individuals who are considering becoming entrepreneurs must carefully consider the various types of companies and organizational structures before starting their own business. Current entrepreneurs also need to consider if it may be beneficial to change their company type or structure to prepare for future challenges and opportunities.
The following resource guide details various types of companies, their unique characteristics and attributes, and what entrepreneurs should consider before adopting a type of structure for their own business.
This type of organization is ideal for individuals who will be the only person actually running the organization. For example, someone who is a freelance wedding photographer—where they conduct all business operations on their own, pay for their own supplies and do not pay wages to other employees—can benefit from a sole proprietorship. However, an individual who runs a wedding photography company that employs multiple photographers may not find this type of organization or structure to be best suited to their business goals.
There are both potential financial benefits and drawbacks that can come from a sole proprietorship. For example, the wedding photographer without any other employees can keep the business profits and earnings as income. However, if that wedding photographer were to incur debt that was unable to be paid back, the proprietor would be held personally liable.
The U.S. Small Business Administration notes that sole proprietors still may need to obtain specific licenses and permits. These can vary depending on the business type as well as where the company is located.
Corporations are types of business organizations that, unlike sole proprietorships, are distinct from its owners and can be held legally liable, the U.S. Small Business Administration reports. There are often more requirements to starting a corporation, but at the same time, corporations often have a greater opportunity to raise capital and funding.
For example, the wedding photographer may purchase all needed camera and video equipment from a larger corporation that sells such equipment. Individuals known as shareholders can own a piece of that corporation by purchasing stock, which can help them potentially earn money and investment returns depending on how the business performs. If the camera corporation is relatively small, its initial investors or shareholders may be family members and friends of the individuals who run the corporation. If the camera company operates on a larger level, there may be hundreds and thousands more shareholders.
Profits earned by a corporation, as well as those earned by its shareholders, are taxed by the government. This is different, however, for S Corporations. This type of corporation passes along profits and losses to the shareholders themselves, according to the IRS. If a standard corporation fails, and if the individuals who incorporated it did so properly based on their state’s guidelines and procedures, their personal assets will be shielded from the corporation’s creditors, according to the Houston Chronicle. For example, if the camera company was unable to pay its debts, the operators of that corporation would likely have to sell their business assets (such as company real estate) but not necessarily lose their unrelated personal assets, such as their own cars or homes.
Generally speaking, there are more risks as well as more potential rewards when operating a corporation. For example, the camera company itself may not thrive with the more limited funding opportunities of a sole proprietorship. Conversely, the wedding photographer may not generate enough profit or revenue to justify a corporate structure for the business.
Limited Liability Company
The limited liability company (LLC) is a popular type of company and business structure. It limits the business owner’s personal liability as well as the ability for multiple individuals, partners, and organizations to participate in the business. In a corporation, the company itself is owned by the shareholders. In an LLC, the company can be owned by several partners, regardless of how much they invested in said company.
In LLCs, “many states don’t restrict ownership, meaning anyone can be a member including individuals, corporations, foreigners and foreign entities, and even other LLCs,” Investopedia notes. “Some entities, though, cannot form LLCs including banks and insurance companies.” For example, Google is a well-known technology company that was once a corporation but now operates as an LLC under a larger company known as Alphabet.
LLCs also face unique tax situations compared to corporations and sole proprietorships. “Depending on elections made by the LLC and the number of members, the IRS will treat an LLC either as a corporation, partnership, or as part of the owner’s tax return (a disregarded entity),” according to the IRS. Specific LLC reporting and tax filing rules can vary by state.
The individual who owns the aforementioned wedding photography business and the person who operates the camera corporation may decide to combine their skills and business acumen to form their own wedding photography agency. This type of company could be considered a partnership.
The website Entrepreneur notes there are two types of partnerships: general and limited. “In a general partnership, the partners manage the company and assume responsibility for the partnership’s debts and other obligations. A limited partnership has both general and limited partners.” In a general partnership, the wedding photographer and the camera equipment owner would both be liable if their agency was to fail or not be able to pay its debts.
In a limited partnership, the photographer and the equipment owner may still both act as general partners, but may also have limited partners as well. These limited partners may be individuals who are providing funding but have no involvement in day-to-day operations, nor are they held liable if the company fails.
Partnerships also provide unique tax opportunities to the partners involved. According to the IRS, partnerships must file annual information returns, but the partners themselves include “his or her share of the partnership’s income or loss on his or her tax return.”
Joint ventures are arrangements where two parties agree to pool together their resources and efforts to achieve a common task or goal, according to Investopedia. A sole proprietorship, corporation, LLC, or partnership could all participate in a joint venture.
For example, a major media corporation may team up with a nonprofit organization in a joint venture with the aim of achieving some sort of philanthropic goal, such as raising $1 million to help battle a certain disease. A joint venture could also involve a large energy and research organization teaming up with a well-known sole proprietor or corporation to develop eco-friendly energy solutions.
The liabilities for joint ventures fall upon the organizations participating in the venture. The joint venture itself does not have tax liability, according to Inc. Instead, that depends on what is determined in the contractual obligation between the organizations participating in the venture.
These types of organizations exist to provide or achieve a goal for the betterment of society and humanity, such as eradicating a certain disease or improving living conditions for a specific population. If it has obtained 501(c)(3) filing status with the IRS, this means the nonprofit is not required to pay certain federal taxes.
Generally, the mission of a nonprofit is not solely to generate revenue or profit, but to raise money to help address certain societal issues and needs. While someone who runs a sole proprietorship or partners in a joint venture may receive profits from said venture, members of a nonprofit organization do not receive any of the income or profits from the organization itself—although they are generally paid a salary
Additionally, nonprofit organizations often have to make their tax filings available to the public, in what is called a Form 990. In these forms, nonprofits often list their highest paid members or employees, and indicate how funding and donations were used within the organization.
A nonprofit can be an effective type of company or organization for an individual who isn’t necessarily concerned with reaping a large income or generating lots of revenue. For those who are dedicated to using their professional skills to help improve society or humanity, this can be an ideal organizational model.
A cooperative, or co-op, is a type of business organization where individuals and parties come together to use the products and services of that organization while also acting as its owners/investors. “These businesses are different from other types of companies, because they are formed and operate for the benefit of their members. In that sense, they are nonprofits,” according to the Houston Chronicle.
For example, in a rural part of the United States, there may be many farmers located in a central area, all of whom provide their services to a few local grocery stores in town. Some of the farmers produce more than others, while others may have stronger relationships with certain suppliers and distributors. Instead of each farmer and partner fending for themselves, they could form a cooperative where they each share each other’s resources and partake in a certain percentage of the profits, ultimately benefiting everyone involved.
There are both benefits and disadvantages to participating in a cooperative. For example, many people participate and contribute to cooperative voting decisions, allowing for many voices to be heard. But for a single entrepreneur who wants more control over a business, this may not be the best type of organization.
The Houston Chronicle notes that “cooperative businesses also exempt members from income tax, up to a point. The members will only be taxed based on the income they receive from the cooperative and not individually or on the corporate level.”
Additional Tips for Entrepreneurs
Each of the businesses and types of companies described here can be beneficial to entrepreneurs. They each allow for unique profit- and revenue-generating situations, but also come with their own restrictions. Regardless of what type of company an entrepreneur chooses, they should also consider the following points of information.
Seek Guidance from Professionals
Among the best individuals to provide advice regarding entrepreneurship and starting a small business are current entrepreneurs themselves. These professionals have experienced firsthand the difficulties and unique circumstances that befall small business owners, and often have found successful strategies to triumph over these particular challenges and issues.
Reaching out to local entrepreneurs, as well as reading information and advice from notable business owners, can help aspiring entrepreneurs in their efforts. Additionally, it’s important to note that not all small businesses are successful (two-thirds fail within ten years). This is why it can also be helpful to reach out to entrepreneurs who have faced difficulties and challenges to glean their advice.
When To Change Your Business Type
There may be a situation where an individual or company is experiencing unanticipated growth, or when a sole proprietor is facing struggles. In these situations, it’s important to remember that just because your organization chose one type of business structure initially, it doesn’t always need to follow that structure going forward.
Understanding when it may be beneficial to adjust their business structure can help entrepreneurs tackle new challenges and unforeseen conflicts. There are additional steps that must be taken to change business structure types, but following those procedures can prove beneficial.
Consider Your Business’ Future Goals and Needs
Will your business be impacted by a proposed change in federal or state taxes within the next year? Are new technological evolutions or roadblocks going to require greater financial investments from your organization? Will a potential expansion overseas require a joint effort with another company, or require you to reevaluate how your business organizes its labor pool?
All of these situations can impact how a business operates, and should be taken into account when initially choosing a company type. While it isn’t possible to predict or foresee every potential outcome, anticipating future events can help entrepreneurs better choose a structure that will provide the most value to their organization.