How to Choose the Right Form of Business Organisation in the US?

Introduction

Starting a new business in the United States requires making many important decisions, including choosing the right form of business organisation in the US. According to the Small Business Administration, there were 31.7 million small businesses in the US as of 2020, accounting for 99.9% of all businesses. Of these, 22.9 million were self-employed with no additional employees, while the remaining 8.8 million had employees. The structure of a business affects its legal, financial, and operational aspects, so it’s essential to choose the right one.

Choosing the right way to set up your business might seem overwhelming, but it is an essential decision that can impact your business’s success and how you handle legal and financial matters. Besides, the business structure that you choose profoundly influences how your business operates, your legal responsibilities, and even how you are taxed. There are several options, including sole proprietorships, partnerships, limited liability companies (LLCs) and corporations. Therefore, whether you are a potential entrepreneur or an established business owner looking to reevaluate your structure, understanding these options is critical to your business’s long-term success and sustainability; here is an insight into how to form and operate under each structure; – 

Various forms of business organisation in the US

Here are some common forms of business organisations in the US:

Sole proprietorship

A sole proprietorship is the simplest form of business organisation, often used by small businesses. The owner is personally liable for the business’s debts and legal actions in a sole proprietorship.

Advantages of a sole proprietorship

• Ease of Creation: Establishing a sole proprietorship is quick, straightforward, and cost-effective.
• Flexibility: Sole proprietors enjoy flexibility in managing their business.
• No State Paperwork: There is no need for state filings to create a sole proprietorship.
• No Separate Tax Filing: Sole proprietors report business income or losses on their personal tax returns, with taxes paid at the individual level; no separate business income tax filing is required.
• No Special Legal Formalities: Setting up a sole proprietorship typically requires only minor steps like obtaining a business permit or paying licensing fees, unlike C corporations, S corporations, or LLCs, which may involve state annual reports or ownership meetings. 

Disadvantages of a sole proprietorship

• Financial Challenges: Many small business owners fail due to insufficient capital to sustain their operations.
• Solo Responsibility: Sole proprietors bear the sole burden of the business’s success or failure.
• Full Liability: The owner is personally liable for all business debts, with no separation between personal and business liabilities.
• Limited Lifespan: A sole proprietorship dissolves upon the owner’s death or retirement, even though the business may continue with a change in ownership.

Partnership

A partnership is a business structure in which two or more people share ownership of a business. Partnerships can be either general partnerships or limited partnerships.

There are two common types of partnerships: limited partnerships (LP) and limited liability partnerships (LLP). Limited partnerships typically involve one general partner with unrestricted liability and other partners with limited liability and control, normally outlined in a partnership agreement. On the other hand, limited liability partnerships extend limited liability protection to all owners, safeguarding each partner from partnership-related debts and actions of other partners.

Advantages of partnerships

• Simplified Setup: In contrast to other business forms, partnerships involve minimal paperwork and legal requirements for establishment.
• Leveraging Expertise: Partnerships enable individuals to pool their skills and knowledge, broadening the collective expertise available to the business.
• Shared Responsibilities: Typically, partners distribute responsibilities, ensuring a balanced workload and preventing one person from shouldering the entire burden.

Disadvantages of partnerships

• Potential for Disagreements: With multiple individuals involved in decision-making, disagreements can arise concerning various aspects of the business.
• Challenges in Ownership Transfer: In the absence of a well-defined agreement outlining procedures, the business could face disruptions if partners decide to end their partnership, making the transfer of ownership difficult.
• Unlimited Liability: One significant drawback of partnerships is the concept of unlimited liability. In a general partnership, each partner is personally responsible for the partnership’s debts and legal liabilities. This means that if the business incurs significant debts or faces legal action, the personal assets of the partners, including their savings and property, could be at risk to cover these obligations.
• Lack of Continuity: Partnerships often lack continuity in other business structures like corporations. The business’s existence is tied to the partnership agreement, and if a partner leaves or dies, it can trigger the dissolution of the partnership. This lack of continuity can be disruptive, especially if the partnership is successful and valuable.

Limited liability company (LLC)

An LLC is a flexible business organisation that offers limited liability protection to its owners while providing pass-through taxation.

The limited liability company (LLC) was created as a fusion of features from both limited partnerships and corporations. It enjoys a taxation structure similar to a partnership, allowing investors to utilise losses and circumvent the double taxation typically associated with corporations. However, akin to a corporation, LLC investors benefit from limited liability, safeguarding their personal assets from potential legal judgments arising from business-related lawsuits.

Advantages of an LLC

• Limited Liability: LLCs provide owners with limited liability protection, shielding their personal assets from business debts and liabilities. Properly filed LLCs use only company assets, not personal ones, to settle business obligations.
• Pass-Through Taxation: Typically, an LLC does not incur taxes at the business level. Instead, income or losses are reported on the owners’ personal tax returns, and any owed taxes are paid individually.
• Profit Allocation Flexibility: LLCs grant owners flexibility in distributing profits and losses among various owners as desired.
• Flexible Management: LLC owners enjoy flexibility in structuring company management to suit their preferences.
• Fewer Ongoing Formalities: Compared to C corporations and S corporations, LLCs entail less annual paperwork and are not subject to the same meeting requirements.

Disadvantages of an LLC 

• Higher Initial Costs: Establishing an LLC entails greater initial expenses compared to creating a sole proprietorship or partnership, and ongoing annual fees are also part of the package.
• Record Separation Obligation: LLC owners are required to maintain a clear separation between their personal and business expenditures, including meticulous record-keeping, whereas sole proprietorships tend to have less stringent formalities.
• Tax Responsibilities: In relation to unemployment compensation, LLC owners may find themselves responsible for handling these payments on their own.

Corporation

A corporation is a separate legal entity that offers limited liability protection to its shareholders. Corporations can issue stock and raise funds through the sale of stock.

There are various forms of corporations that exist, including;

C Corporations 

C corporations, owned by shareholders, are treated as separate entities for taxation purposes, necessitating their tax return and taxation based on the business’s earnings. Potential double taxation may arise when shareholders or owners file individual tax returns for dividends from the corporation’s income. 

S Corporations 

An S corporation, often referred to as an S corp, is a specialised form of corporation specifically designed to circumvent the dual taxation drawback associated with regular C corporations. S corporations enable profits, as well as certain losses, to be directly funnelled into the personal income of owners, thus avoiding corporate tax rates. While the tax treatment of S corporations may vary among states, most align with federal guidelines and tax shareholders accordingly. Some states impose taxes on S corporations for profits exceeding a set threshold, while others do not recognise the S corp election, treating the business as a C corporation. Additionally, S corporations, like C corporations, possess an autonomous existence; they can continue operating without disruption even if a shareholder departs or sells their shares. 

B Corporations 

B corporations, also known as benefit corporations, prioritise corporate social responsibility. B corps distinguish themselves from C corps through purpose, accountability, and transparency, but their tax treatment remains the same.

B corps operate with a dual focus on both mission and profit. Shareholders hold these companies responsible for delivering public benefit alongside financial profitability. Certain states mandate that B corps submit annual benefit reports illustrating their contributions to the greater good.

While various third-party B corp certification services exist, they are not obligatory for a company to obtain legal B corp status in states where this corporate structure is recognised.

Closed Corporations

Closed corporations, often managed by a select group of shareholders, are not publicly traded and enjoy the advantages of limited liability protection. These entities, also known as privately held companies, possess greater flexibility than their publicly traded counterparts. 

Non-profit Corporations

Nonprofit corporations are established to engage in charitable, educational, religious, literary, or scientific endeavours. Given their public-benefitting mission, nonprofits can attain tax-exempt status, exempting them from state and federal income taxes on their earnings. Nonprofit corporations must adhere to organisational regulations akin to those of a standard C corporation, and they are also subject to specific guidelines concerning allocating any profits they generate. 

Advantages of corporation

• Limited liability: shareholders of a corporation are not personally responsible for its debts. Instead, their risk is confined to their invested equity.
• Continuity: Corporations remain unaffected by changes in ownership due to death or share transfers among owners. This provides stability and continuity, favoured by investors, creditors, and consumers.
• Capital: Incorporation facilitates the process of raising substantial capital from multiple investors, enhancing financial opportunities for your business.
• Tax Advantages: Corporations enjoy tax deductions for various company expenses, encompassing health insurance premiums, salaries, taxes, travel costs, equipment, and more.

Disadvantages of corporation

• Double Taxation for C-Corporations: C-corporations encounter double taxation, where the corporation is taxed at the corporate rate prior to profits being distributed to shareholders, who are then subject to individual-level taxation.
• Ongoing Record-Keeping Obligations: Except for S-corporations, the corporate structure necessitates significant record-keeping and administrative tasks.
• Limited Owner Involvement: In cases where numerous investors lack a clear majority interest, management teams often oversee day-to-day business operations, reducing the direct involvement of owners.

Cooperative

A cooperative is a business owned and controlled by its members, who share in the profits and benefits of the business.

Advantages of a Cooperative

• Enhanced Funding Opportunities: Cooperatives can access government-sponsored grant programs, depending on their specific type and purpose.
• Democratic Governance: Cooperatives adhere to a “one member, one vote” principle, ensuring that each member’s voice carries equal weight in decision-making, irrespective of investment level.
• Stability and Continuity: Cooperatives permit members to join or depart without disrupting the business’s structure or causing dissolution.

Disadvantages of a Cooperative

• Capital Generation Challenges: Larger investors might opt for alternative business structures that offer them a larger stake, as cooperatives treat all investors equally, regardless of size.
• Accountability Concerns: Cooperatives often have a more relaxed organisational structure, which can lead to issues if some members do not actively participate or contribute to the business, potentially disadvantageous to others and discouraging member engagement.

Legal requirements for each business organisation

These are just some of the legal requirements for each business organisation. Entrepreneurs need to research and understand all the legal requirements and regulations associated with their chosen structure to ensure compliance with state and federal laws. Consulting with a business attorney or accountant can help navigate the complex legal landscape of starting and operating a business.

LegaMart is a platform that assists entrepreneurs and small business owners with the legal requirements of starting and managing their businesses, including choosing the right form of business organisation. The platform offers various legal services, including support with forming a business, drafting legal documents, and navigating regulatory requirements. 

Sole proprietorship

• Must obtain any necessary licenses and permits for the business
• Must file a “doing business as” (DBA) form with the state if the business operates under a name other than the owner’s name
• Must report all business income and expenses on their income tax return
• May be required to collect and remit sales tax

Partnership

• Must file a partnership agreement with the state outlining the terms of the partnership
• Must obtain any necessary licenses and permits for the business
• Must report all business income and expenses on the partnership’s tax return
• May be required to collect and remit sales tax

Limited liability company (LLC)

• Must file articles of organisation with the state
• Must create an operating agreement outlining the management and ownership structure of the LLC
• Must obtain any necessary licenses and permits for the business
• Must report all business income and expenses on the LLC’s tax return
• May be required to collect and remit sales tax

Corporation

• Must file articles of incorporation with the state
• Must create bylaws outlining the management and ownership structure of the corporation
• Must obtain any necessary licenses and permits for the business
• Must report all business income and expenses on the corporation’s tax return
• Must hold regular shareholder meetings and maintain proper corporate records and filings

Cooperative

• Must file the Articles of Incorporation to make your cooperative official
• Must create Bylaws that complies with state law
• Must create a Membership Application.
• Must conduct a Charter Member Meeting and Elect Directors. 
• Must obtain Licenses and Permits.

Benefits of different forms of business organisations

Choosing the right form of business organisation is critical to minimising personal liability, maximising tax benefits, and ensuring the smooth operation of your business. There are several benefits to choosing the right form of business organisation. Each structure has advantages and disadvantages, so it’s essential to consider your business needs and goals before deciding. Here are some of the benefits of different forms of business organisation:

Sole proprietorship

One of the most significant benefits of a sole proprietorship is the ease and affordability of setting it up. This structure requires minimal paperwork and no legal fees, making it an attractive option for small businesses and solo entrepreneurs. Additionally, the owner has complete control over the business and can make decisions quickly without consulting with other partners or shareholders.

Mary’s Cupcakes is a small bakery owned and operated by Mary. She started the business as a sole proprietorship because it was easy and inexpensive to set up, and she wanted to maintain complete control. Mary has been able to deduct business expenses from her personal income taxes and has had no issues with personal liability. Her business has grown steadily, and she has been able to reinvest profits to expand her product line and hire part-time employees.

Partnerships

Partnerships offer shared management responsibilities and decision-making authority, allowing partners to contribute their skills and expertise. Partners can share in the profits and losses of the business, providing financial stability and flexibility. Partnerships are also relatively easy and inexpensive to set up and maintain.

Airbnb is an online platform connecting people who need accommodation with people with extra space. The company was founded as a partnership between two friends who saw an opportunity to monetise unused living spaces. By operating as a partnership, the founders were able to split management responsibilities and share profits. This structure has allowed Airbnb to grow into a multi-billion dollar business and expand into new markets worldwide.

LLCs

LLCs offer the liability protection of a corporation with the tax benefits of a partnership. Owners of an LLC are not personally liable for the debts and obligations of the business. This means that if the company incurs any debts or legal issues, the business assets are at risk, not the personal assets of the members. Additionally, LLCs offer flexibility in management and ownership structure, allowing members to customise the business structure to fit their needs and goals.

Warby Parker is an eyewear company that was founded in 2010. The founders chose to set up the company as an LLC because it offered the liability protection of a corporation and the tax benefits of a partnership. This structure has allowed Warby Parker to proliferate while minimising personal liability. The company has expanded from its original online-only model to include brick-and-mortar stores, and it has been able to attract significant investment from venture capitalists.

Corporations

Corporations are separate legal entities from their owners, providing the most significant liability protection of any business structure. This means that the owners are not personally liable for the debts and obligations of the business. Corporations can also raise large amounts of capital from investors and issue shares of stock to employees as part of their compensation packages. However, corporations have complex regulations and are required to pay corporate income tax on their profits.

Apple Inc. is one of the world’s largest technology companies, with a market capitalisation of over $2 trillion as of 2021. Apple was founded as a corporation, which has allowed it to raise large amounts of capital from investors and issue shares of stock to employees as part of its compensation packages. The corporate structure has also allowed Apple to expand globally and protect its intellectual property through patents and trademarks. However, the company is subject to complex regulations and is required to pay corporate income tax on its profits.

Factors to choose the right form of business organisation in the US

Here are some factors to consider when choosing the right form of business organisation in the US.

Liability

One of the most important factors to consider when choosing a business structure is liability. Some structures, such as sole proprietorships and partnerships, offer little to no protection for personal assets in the event of legal action or debt. In contrast, corporations and limited liability companies (LLCs) provide a shield that separates personal assets from business assets.

Tax implications

Another significant factor to consider when choosing a business structure is tax implications. Different business structures have different tax implications, and choosing the right structure can result in significant tax savings. For example, pass-through entities like partnerships and co-owned LLCs do not pay corporate income tax. Instead, the profits and losses are passed to the owners, who report them on their tax returns.

Management and control

Another factor to consider is management and control. Some structures, such as sole proprietorships and partnerships, offer the owner(s) full control over the business. Other structures, such as corporations, have a more complex management structure, with a board of directors and officers responsible for making major decisions.

Funding

The structure of a business can also affect its ability to raise funds and obtain financing. Some structures, such as corporations, are more attractive to investors because they can issue stock. In contrast, sole proprietorships and partnerships may have limited options for raising funds.

State laws and regulations

Finally, it’s essential to consider state laws and regulations when choosing a business structure. The law governing business structures varies by state, so it’s important to choose a structure that adheres to the particular state’s law.

Can I change my business structure?

One central question that most business owners frequently ask is whether it is permissible to alter your business structure once you have already established your business legally. The answer to this is in the affirmative. This is because the way you legally organize your business is not set in stone; as your business expands, adapts, and transforms, adjusting its legal structure might be a good idea. For example, as it grows, a small business may transition from a sole proprietorship or basic partnership to a more intricate one, such as an LLC or corporation. Alternatively, a larger corporation may simplify its structure to match shifts within its company.

Changing your business structure can impact various aspects, such as your personal legal liability, ownership, income tax, and how the business functions. While several structures reduce the owner’s legal liability, there are exceptions, such as a sole proprietorship. Besides, some structures restrict who can be an owner. For instance, non-U.S. citizens outside the U.S. typically cannot own an S-corporation. Moreover, specific structures like C-corporations demand more administrative effort and cost. Therefore, some of the reasons that a business may opt to restructure may include;  

• For growth: If you run a small business like a sole proprietor, you might need to change how your business is legally set up as it grows. Alternatively, if you have a more complicated business structure, like a big corporation, you should switch to a simpler setup to save money and time.
• When the business is operating at a loss: Sometimes, businesses change their legal structure when they’re not making as much profit as they should. If your current structure does not match how your business works, it could hold your company back.
• To protect the owner or shareholders from being personally responsible for business debts. For example, Sole proprietorships and general partnerships fail to provide this protection, unlike corporations and LLCs. If you’re worried about your personal assets, you might change your business structure to limit liability.
• Engaging a partner: If you started your business by yourself, but at some point, you might decide to bring in a partner. If you do, you’ll need to change your business structure to a partnership, corporation, or LLC with multiple members. 

How can you change your business structure?

The steps involved in changing your business structure depend on your location, your existing business form, and the new business structure you intend to adopt. Some of the steps that you might consider include:

Explore different business structure choices

Before you decide to switch your business type, take the time to research the various available forms of business entities. While another option might seem more appealing, it is essential to recognize that each type has its pros and cons. Additionally, it is essential to note that business structures can vary significantly regarding liability, tax implications, and ownership.

Complete the paperwork

Once you have confirmed that changing to your desired business structure is feasible, it is time to get started on the paperwork. Changing your business structure involves a process similar to when you initially established your business entity. You will need to officially register your new structure with your state by

• Completing required forms.
• Drafting legal documents.
• Submitting these documents and forms to your state authorities (and covering associated fees).
• Transferring liabilities and assets to the new business entity.
• Concluding the former business entity, if necessary.

Your state might require you to select a distinct business name and officially register it. In most cases, when you change your business structure, you’ll need to obtain a new federal employer identification number (FEIN) from the IRS.

Furthermore, when you change your business entity, it is important to check whether you need to reapply for business licenses and permits to continue your operations legally.

If the shift in structure necessitates dissolving your current business, you may need to:

• Secure a new Employer Identification Number (EIN).
• Request a license for the new business.
• Establish a fresh business bank account.
• Update your contacts/ Keep your contacts informed

When changing your business structure, it is crucial not to keep essential parties like your bank, suppliers, insurance company, and customers in the dark. Swiftly update your contacts, particularly if the restructuring impacts them.

Changing your business structure might also affect how you manage your finances, such as separating personal and business funds. For instance, if you’re transitioning to an LLC or corporation, you’ll need to establish a distinct bank account for your business. Reach out to your bank for guidance on setting up this new account. 

Seek professional advice

The way you structure your business has a significant impact on its operations. Therefore, it is highly advisable to consult professional services such as a qualified attorney before changing your structure.

Conclusion

To sum it all up, choosing the right form of business organisation is crucial because it can affect the success of the business. Entrepreneurs can choose the structure that best suits their needs and goals by considering liability, tax implications, management and control, funding and financing, and state laws and regulations. It’s always a good idea to consult with an attorney or accountant when making this decision to ensure compliance with state laws and regulations.

Frequently asked question

What happens to the business if I am no longer there?

To ensure business continuity, consider establishing a corporation or incorporating provisions in your partnership or LLC operating agreement that enable the business to persist independently of your involvement. In the case of a sole proprietorship, as there is no distinct business entity apart from yourself, the business ceases to exist upon your departure, passing, or inability to manage it.

Should I make my LLC an S Corp?

If you operate as a sole proprietor, opting for an LLC can be advantageous as it distinguishes your business assets from personal ones. You have the flexibility to modify the structure later or even establish a new S corporation if needed. S corporations are better suited for intricate businesses with multiple stakeholders, involving elements like a board of directors, a limit of 100 shareholders, and increased regulatory obligations.

Can I change my business structure in the future?

Yes. You may consider a change in your business structure when you identify promising opportunities that your current setup cannot effectively exploit. In such an instance, you can modify your business structure at any stage to better align with your evolving business requirements. However, to initiate this change, you need a clear understanding of the desired business entity you wish to transition to. Take time to evaluate your motivations, assess how it enhances your company, acknowledge potential challenges, and comprehend the prerequisites for the switch. Additionally, seek guidance from legal experts, accountants, and your financial team to thoroughly examine these aspects and ascertain whether a shift in business structure would benefit your organisation.

Do I need an attorney to set up the business?

While establishing a sole proprietorship doesn’t necessitate legal assistance, other business structures entail state registration, agreements, and legal procedures. Nonetheless, it’s often advisable, though not mandatory, to seek guidance from an attorney to ensure proper handling of all legal matters.

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