How to Choose a Business Structure

A Look at the Pros and Cons of Each Legal Structure

May 3, 2009 Susan Brown

One should consider the pros and cons of each organizational structure when choosing the most suitable form for a business.

Choosing the business structure that is most appropriate for a particular business is dependent on carefully considering the pros and cons of each structure. There are several organizational structures to choose from: sole proprietorship, partnership, corporation, and LLC. Each one offers its own set advantages and disadvantages

Sole Proprietorship

The sole proprietorship is the simplest business structure and the least expensive to form. It is owned by either a single person or a married couple.

The pros:

  • Setting up this structure is simple and inexpensive.
  • The sole proprietor has complete control over all business decisions.
  • All the income generated by the business flows through to the owner.
  • The business' profit and loss is recorded on the owner's personal tax return
  • Closing or selling a sole proprietorship is relatively easy.

The cons:

  • Sole proprietors are held personally liable for all business debts or damage. This means that the owner's personal assets are at risk.
  • It will be harder to establish a business credit rating that is separate from the owner's individual credit rating and asset pool.
  • It may be harder to get outside financing- especially from banks and commercial lenders.
  • Sole proprietors must deal with a high self-employment tax
  • Certain benefits, such as health insurance, are not directly deductible from business income

Partnership

A partnership consists of at least two people. Like the sole proprietorship, partnerships are relatively simple and inexpensive to form. A partnership, however, requires a legal agreement between all the involved partners detailing how they will own and operate the business.

The pros:

  • Setting up this structure is simple and inexpensive.
  • Owners can pool assets, and with more people involved it may be a little easier to get outside financing
  • All the income generated by the business flows through to the owners.
  • More people means more experience and skills.

The cons:

  • The partners are held personally liable for business debt or damages.
  • Both income and management is shared among all the partners.
  • Certain benefits are not directly deductible from business income.

Corporation

The corporation is the most common business structure among bigger companies. Of all the business structures, it requires the most time and money to form, and it is subject to numerous licensing fees and government regulations. The owners of a corporation are its shareholders. They are responsible to elect a board of directors to oversee the business.

The pros:

  • A corporation is a legal entity separate from its owners. So shareholders have limited liability for the corporation's debts or judgments held against it.
  • Corporations generally have greater access to financing whether through selling stock or tapping banks and commercial lenders.
  • Employee benefits can be directly deducted from corporate income.
  • In certain cases, the business can become an "S corporation" and thereby avoid double taxation.

The cons:

  • It requires a lot of time and money to set up.
  • A corporation must comply with numerous Federal and State regulations.
  • A corporation is subject to double taxation.

Limited Liability Company (LLC)

An LLC combines the limited liability of a corporation with the tax advantages and flexibility of a partnership. LLCs do not have stock, and owners are considered self-employed. Income can either pass through to the owners, or can be taxed like a corporation.

The pros:

  • This structure provides a lot of flexibility, which is good for small businesses.
  • It offers limited liability to its owners.
  • It can avoid double taxation.

The cons:

  • A self-employed status can mean higher taxes.
  • It can not raise money through the sale of stock.

In closing, one should carefully consider the pros and cons of each business structure to choose the one that makes the most sense for the business and its owners.

The copyright of the article How to Choose a Business Structure in Accounting is owned by Susan Brown. Permission to republish How to Choose a Business Structure in print or online must be granted by the author in writing.
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