There are high risks in business, yet individuals are attracted to it because of the profits it generates. To start a business, you don’t need to possess any special skills or knowledge. What you need are good ideas for a business and action plans to implement them. There are also several other factors involved in it. In fact, businesses can take different forms. Selecting the right type is one of the most important decisions that entrepreneurs make. So, in this discussion, we will explore the different types of business and understand which is suitable for each enterprise.
What are the different types of businesses?
When starting a business, several factors such as taxes, paperwork, liability, and funding need to be taken into account. Businesses differ from one another based on these factors. The following are the types of businesses: sole proprietorship, partnership, limited liability company, and corporation.
Let’s explain them one by one:
1. Sole proprietorship
The best part about a sole proprietorship is that there are fewer regulations, which makes it a comparatively simpler business choice. People who like working alone or being in control can go for this type of business, where they will be solely responsible for the company.
There is no need for a separate legal identity for the business, as the identity of the sole proprietor coincides with the business. It is actually a good option for small businesses as it has the potential to be transformed into other complex business types. The sole proprietorship processes are dependent on the area of residence, but overall it requires minimum documentation.
The sole proprietors get the benefits of taxes, as they only have to pay for the personal income tax on the profits earned by the company. Although there are several benefits of sole proprietorship, they are still limited to the times when business is doing good.
On the flip side, since the company does not have a separate legal identity, the sole proprietors need to face personal liability for all the debts. In other words, if the company cannot meet its obligations, then the owner has to repay the debts. Additionally, obtaining funds can be a hurdle for this type of business, as inventors check the personal credit history of the owner.
Features of a Sole Proprietorship Business
- Owned by one person.
- No legal distinction between owner and business.
- Easy to set up and manage.
- The owner has unlimited personal liability.
- Profits are taxed on the owner’s personal income tax.
2. Partnership
In this kind of business, there can be two or more people involved and the income or losses are distributed between them. It is further classified into three types: general, limited, and incorporated limited partnerships.
2.1 – General partnership
In this partnership, each partner is responsible for the business. So, each one has unlimited liability for the debts it incurs. Even though it is one of the easiest types of partnerships to form, there are still risks involved. Here, the partners are responsible for each other’s actions. So if one partner makes a wrong decision, then the personal assets of the other partners can also be claimed.
2.2 – Limited partnership
In this type of partnership, the liability is limited to the contributions of the partners. This is a suitable option for passive investors who aren’t interested in getting involved in everyday business activities.
2.3 – Incorporated limited partnership
Within these types of business partnerships, members have limited liability for the debts, but they need at least one general partner. Here, only the general partner takes the unlimited liability, whereas the limited partners are concerned with taking liability for their financial stake. This means the general partner is personally liable when the business cannot meet its financial obligations.
Features of a Partnership Business
- Owned by two or more people.
- Shared profits and liabilities.
- Each partner contributes to all aspects of the business.
- Profits are taxed on partners’ personal income tax.
3. Limited liability company
In these types of businesses, individuals can limit their liability for protecting their personal assets. It provides flexibility to owners, partners, and stakeholders. They are provided with the option to adopt the tax system of either sole proprietorship, partnership, C corporation, or S corporation.
Here, the company has its own legal identity, so owners are not personally liable for its operation and debts. Also, the income of the business is treated as the owner’s income. Consequently, it is taxed at the member level, and not the company level, eventually avoiding double taxation.
There are no limitations on the number of owners that a company can have. The direct benefit is flexibility, which is provided in terms of ownership and taxation. But there are downsides to this type of business. It can be a costly affair when compared to sole proprietorship and partnership. And they need to submit the agreement which includes the governance of the limited liability company. Some venture capitalists only invest in corporations, so it is not a suitable type to get their funding.
Features of a Limited Liability Company (LLC)
- Owners are called members.
- Members have limited personal liability for business debts.
- Profits not subject to corporate taxes; can be passed through to members’ individual tax returns.
- More flexibility in the management structure.
4. Corporation
The owners create a corporation to avoid being personally liable for the debts or legal disputes of the business. So, the corporation is liable for the business and not its shareholders. It is further classified into several types: C, S, B, and non-profit corporations.
4.1 – C Corporation
The cost to form a C corporation is high, but simultaneously, it offers more personal liability protection. Also, the organization is taxed as a business entity and when owners receive profits, they are taxed as well. Since the corporation has its business entity, if the owner decides to leave the company, it will continue to exist. This is unlike the sole proprietorship or partnership businesses, which get affected.
4.2 – S Corporation
The S corporation is formed with the aim of avoiding double taxation. It provides the owners with the liability protection of a corporation. But, on the flip side, the disadvantage is that there are higher legal and tax service costs.
4.3 – B Corporation
The B corporation is formed with the intention of generating higher profits. The shareholders of these corporations expect them to provide financial benefits along with providing some benefits to the public.
4.4 – Non-profit Corporation
The intention of forming a non-profit organization is to carry out philanthropic activities. The corporation works towards improving the well-being of the public, which is why they do not have to pay taxes on income. The income generated through their work is further invested in the operations of the corporation and its future developments.
Features of a Corporation
- Legal entity separate from its owners (shareholders).
- Limited liability for shareholders.
- Can raise funds by selling stock.
- Subject to corporate tax rates.
- More complex to establish and manage.
A comparison of different business types
| Business Type | Ownership | Liability | Taxation | Best For |
|---|---|---|---|---|
| Sole Proprietorship | One person | Unlimited personal liability | Owner’s personal income tax | Single owners looking for simplicity |
| Partnership | Two or more people | Joint liability | Partners’ personal income tax | Small groups who want to share profits and liabilities |
| Limited Liability Company (LLC) | Members (can be individuals or other businesses) | Limited liability for business debts | Pass-through taxation to members’ individual returns | Those seeking liability protection with flexibility in management and tax benefits |
| Corporation | Shareholders | Limited liability for shareholders | Subject to corporate tax rates | Larger businesses seeking to raise funds through selling stock, and wanting to limit shareholders’ liability |