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BUYER'S GUIDE

How To Choose The Right Structure For Your Business

When you start a business, you will need to determine how to structure your business. A business can be structured as sole proprietorship, a partnership, a limited liability company, a non-profit organization or a corporation. It is important to know the advantages, disadvantages, and purpose of each type of structure to determine which structure offers the most benefits and protection for both you and your business.

Sole Proprietorship: A sole proprietorship is a business that is owned by one individual or married couple. This is the most common form of business structure.

Advantages:

  • A sole proprietorship is the easiest and least expensive business structure to organize.
  • The owner does not answer to a board of directors or stockholders.
  • The owner receives all revenue from the business.
  • The business is easy to close down if necessary.
Disadvantages:
  • The business owner is responsible for all debts incurred by the business.
  • The business assets, as well as the owner's personal assets are at risk.
  • It may be more difficult to get financial backing than it would be for another type of business structure.
  • In the eyes of the law, the business and the owner are viewed as one and the same.

Partnership: A partnership is formed when two or more people own one business. There are three different types of partnerships: a general partnership, a limited partnership, and a joint venture. A general partnership exists when the partners share responsibility for the management, liability, profits, and losses associated with the business. A limited partnership exists when most of the partners’ liability is limited to the extent of their investment. Their management of the business operations is usually limited as well. A joint venture is just like a general partnership, but is usually only for a limited amount of time or until the completion of a specific project.

Advantages:
  • Easy and less expensive to set up than a corporation, limited liability company, or non-profit organization.
  • The owners receive all revenue from the business.
  • The partnership can easily be dissolved.
  • It is easier to get financial backing since there is more than one owner.
  • The partners are protected by the terms of their partnership agreement.
Disadvantages:
  • All owners of the partnership are responsible for all debts incurred by the business, except in the cases of limited partnership.
  • The personal assets of the partners are at risk, as are the business assets, except in the cases of limited partnerships.
  • The business and the partners are viewed as one and the same, and one partner can take actions that legally bind the other partners.
  • The partners are bound by the terms of their partnership agreement.
Limited Liability Company (LLC): Limited liability companies work like corporations, but have the benefits of limited partnerships. Limited liability companies are owned by a mixture of individuals, corporations, other LLC's, or foreign entities. Limited liability companies must not have more than two of the four characteristics that are used to define a corporation.

Advantages:
  • Owners, referred to as members, have the liability protections of a corporation.
  • All members are protected by the LLC agreement.
  • LLC's are formed for a specific time period, as stated in the LLC agreement.
  • LLC's are taxed as partnerships.
Disadvantages:
  • Some businesses, such as banks, insurance companies, and non-profit organizations do not qualify as LLC's.
  • All members are bound by the LLC agreement.
  • The LLC is formed for a specific time period, and when the expiration of the LLC occurs, members must vote on whether the LLC will continue or not.
Non-Profit Organization: A non-profit organization is defined as an organization, or business, that does not have a primary purpose to make a profit. They are usually funded by donations. Non-profit organizations are usually controlled by a trust, a board of directors, or an association.

Advantages:
  • Non-profit organizations usually have a tax-exempt status.
  • Non-profit organizations enjoy the same benefits and protections as corporations.
Disadvantages:
  • No dividends are ever issued to a non-profit organization’s shareholders, owners, or other interested parties.
  • There are very strict governmental laws that non-profit organizations must adhere to.
Corporation: A corporation is a business that is considered a separate entity from those who own it. Corporations are owned by shareholders, who elect a board of directors to oversee the management and policies of the business. The four characteristics that define a corporation are: continuity of life, centralization of management, limited liability to the extent of the corporation’s assets, and free transferability of ownership interests. There are three different types of corporations, with each type having it's own advantages and disadvantages.

C Corporation: A C corporation is the most common type of corporation. A C Corporation may have an unlimited number of stockholders. Due to the legal nature of the corporation, stockholders are protected, personally, up to the amount of their investment, from the creditors of the corporation.

Advantages:
  • Personal assets are protected from debts and liabilities incurred by the corporation.
  • A C corporation does not end when a shareholder dies or leaves the business.
  • C corporations have several tax reductions and benefits.
  • Operating capital can be easily raised by the sale of stocks or bonds in the corporation.
  • A C corporation can retain some of its profits without the owners paying taxes on those profits.
Disadvantages:
  • C corporations have many rules and regulations that are governed by the state where the articles of incorporation were filed.
  • C corporations are more expensive to set up. There are many legalities involved.
  • There is a possibility of being taxed twice. You can be taxed once as a corporation, and again as an individual when profits are distributed as dividends, or if you liquidate the corporation.
  • While shareholders are taxed on the dividends that are disbursed to them, they cannot deduct any losses the corporation takes.
  • Extensive record keeping is required.
S Corporation: An S corporation is a domestic corporation with no more than 75 stockholders, and each stockholder must be a citizen of the United States. S corporations have the same advantages and disadvantages as C corporations with a one exception: Both income and losses are passed through to the shareholders and reported on their individual tax returns. The corporation itself does not pay income taxes. Furthermore, only one class of stock may be offered, and only individuals may be shareholders.

Professional Corporation: Professionals who wish to incorporate are required to do so as a professional corporation. Which professionals are required to incorporate under the professional corporation status varies from state to state, but in almost all states this includes: accountants, engineers, healthcare professionals, lawyers, psychologists, social workers, and veterinarians. Professional corporations have all of the same advantages and disadvantages of C corporations with one exception: the corporation does not protect the professional from liability for his or her negligence or malpractice. It can, however, protect against the liability for the negligence or malpractice of a associate.

You should also note that it may be cheaper to incorporate in a state other than the one that you live in. Before deciding which business structure will work best for you and your business, you should seek the advice of an attorney, and carefully consider all of the options available to you.

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