1. When growing your business, whether domestically or internationally, it is crucial to consider the best type of business entity for your business.
2. Sole proprietorship is a straightforward, usually default, business structure or entity: However, it subjects the business owner or entrepreneur to unlimited liability.
3. Partnership is a popular business entity or structure for professional service firms, though, as with sole proprietorship, it means that all business owners take on significant liability.
4. Incorporated business entities or structures, such as Limited Liability Companies (LLCs) or corporations strictly limit the liability of the ultimate business owners. However, they tend to be more complicated and expensive to set up than sole proprietorships or partnerships.
When setting up or growing your business, it is essential to think carefully about the type of business entity you will use as the vehicle for your enterprise. While sole proprietorship is the most common type of business structure in the world, it is not appropriate for many businesses.
Here we set out the main types of business entity available for your business, sole proprietorship, partnership, limited liability company and corporation, and consider the pros and cons of each.
What are the different types of business entity?
1. Sole proprietorship
A sole proprietor (also known as a ‘sole trader’ in some jurisdictions), is an individual operating a business under their own personal identity: There is no legal separation between the business and the individual who owns it.
Depending on the country or region, a sole proprietorship may need to be registered with tax authorities or other government regulators to ensure tax and business law compliance.
Pros and cons of sole proprietorship
Pros of sole proprietorship
Cons of sole proprietorship
Alongside the benefits of sole proprietorship, this business model is not without its disadvantages, namely:
A partnership (also known as a general partnership), involves two or more individuals going into business together according to the terms of a partnership agreement. This business form is particularly common among professional service forms such as accountancy and legal practices.
Pros and cons of partnerships
Pros of partnership
Cons of partnership
3. Limited Liability Companies (LLCs)
A Limited Liability Company (LLC) is the name given in the US to a special form of incorporated legal entity.
An LLC is owned by its members, who may be one or more individuals, or may also be incorporated entities. In an LLC, taxes are ‘passed through’ to the members, so that the company itself doesn’t pay taxes, and the individual members simply pay a tax on any profits in their own personal tax returns.
They are generally set up via lodging a ‘Certificate of Organization’ or ‘Articles of Organization’ with state authorities.
LLCs need not have a board of directors, but may have a ‘board of managers’ or an individual manager.
Pros and cons of LLCs
Pros of LLCs
Cons of LLCs
4. C Corporation
A C corporation (‘C corp’, like an LLC, is an incorporated body in the United States. However, unlike an LLC, corporate income tax is paid on C corp profits, and they must file their own tax returns. Most large companies in the US are C corps. This would also generally be the business form used if an overseas company was setting up a foreign subsidiary in the United States. Strictly speaking, C Corp is a tax designation rather than a business type — the business type is ‘corporation’: Where a corporation is eligible for, and applies to be designated for, ‘pass through’ of income to the members, they are known as an ‘S corporation’ or ‘S corp’.
In a corporation there is a strict delineation between the owners (members), the governors (the board of directors) and the ultimate managers (the officers) of the corporation.
Pros and cons of C corporations
Pros of C corps
Cons of C corps
Video: Which type of business entity? LLC or S-corp?
Choose the right type of business entity with Horizons
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Frequently Asked Questions (FAQ)
What are the four main types of business entity?
In the US, the four main types of business entity are sole proprietorship, partnership, limited liability company (LLC) or corporation (whether designated as a C corporation or an S corporation).
What is the difference between a C corp and an S corp?
'C corporation' and 'S corporation' are different tax designations for corporations in the United States. A C corporation of 'C corp' pays corporate income tax on all its profits, whereas an S Corporation of 'S corp' can 'pass through' profits directly to members who pay personal income tax on those profits.