Business Structure for Small Business

Business Structure Outline

Your business plan introduction should include some basic facts about the current status of your business, particularly if the company already exists as a corporate entity. Letting the reader know how your business structure is currently set up is important but straightforward. 

The following information should be included in the Business Structure section of your business plan:  

• Business Status
• Type of Entity
• Current Ownership
• Current and Past Funding

The template below provides more details and examples for writing the business structure section of your business plan.  

Business Structure Template

While the nuances of the different choices of business plan structure require some reading and understanding, in the end, you’ll select the business structure that’s right for you and include that in your business plan. This section of your business plan should be in a concise, easily readable format. Remember, it is a summary of facts and needs little, if any, editorializing.

Use the template below to Include information covering each item:

• One to five sentences on the status of the business (started or to be formed), when it was founded, and where it is or will be located.
• Type of entity (C Corp, S Corp, LLC, LLP, or Sole Proprietorship)
• Who owns the company, and how much each person owns. If there are more than two owners, include a simple “cap table” that shows the amount of capital invested by each person and each person’s ownership percentage.
• How the company has been funded to date (how much, by whom, and when was it invested).

Business Structure Types

There are many different types of business structures. Being familiar with the various business structure types will guide you toward the one best suited for you. Ultimately, this is an essential legal and tax decision you’ll want to make with your professional advisors. This article should help you prepare for that discussion. Your final decision will depend on both business and personal circumstances.   

Sole Proprietorship

A sole proprietorship is a business owned and operated by one person. This is the simplest form of business structure, and the owner has complete control over all aspects of the business. It is also the easiest and least expensive to set up. The owner, or proprietor, is responsible for the debts and obligations of the company and has little protection against legal matters that may arise.  

Advantages: Easy to set up and operate, the owner has complete control over business decisions, and all profits go to the owner. This type of business structure is ideal for small businesses owned and operated by a single person, such as freelance consultants or home-based businesses.

Partnership

A partnership is a business owned and operated by two or more people who share in the profits and losses of the business.

Advantages

Partnerships are easy to set up and operate, and each partner can contribute different skills and resources to the business. Partners also share the risks and liabilities of the company. This type of business structure is ideal for businesses that require different skills or resources that multiple owners, such as professional services firms like law firms or accounting firms, can provide.

Limited Liability Partnerships and Limited Liability Companies

LLP versus LLC? 

A Limited Liability Partnership (LLP) is a type of business structure that combines a corporation’s liability protection with a partnership’s tax benefits. Here is some information on LLPs and how they differ from LLCs:

Limited Liability Partnership (LLP) 

An LLP is a partnership in which each partner has limited liability for the partnership’s debts and obligations. This means that each partner is not personally responsible for the actions of the other partners, and they are only liable for the amount of their investment in the business. For example, professional service firms such as law, accounting, and architecture firms often use LLPs.

LLPs allow for flexibility in management, and profits and losses are passed through to the partners’ personal tax returns.

LLPs are ideal for professional service firms where each partner has a unique skill set or area of expertise. This type of business structure is beneficial for firms where partners want to be protected from the actions of other partners but still want to share in the profits and losses of the business.

Limited Liability Company (LLC): 

An LLC is a hybrid business structure that combines the flexibility and tax benefits of a partnership with the limited liability protection of a corporation.

Differences: The main difference between an LLP and an LLC is that an LLP is typically used by professional service firms, whereas an LLC can be used for many business types. Additionally, an LLP must have at least one general partner liable for the partnership’s debts and obligations, while an LLC can have all members shielded from personal liability.

LLCs are ideal for small businesses that want a corporation’s liability protection but also want a partnership’s flexibility and tax benefits. They are often used by businesses owned and operated by a few individuals, such as family businesses, small retail shops, or restaurants.

Overall, choosing an LLP or an LLC depends on the specific needs and goals of the business. It’s important to consult with a tax or legal professional to determine which type of business structure is best for your business.

Corporation

A corporation is a legal entity that is separate from its owners. It is owned by shareholders, who elect a board of directors to oversee the company’s management. The two types of corporate business structure examples most often used by small businesses are a C-Corp and an S-Corp. Each is discussed in more detail below.  

C Corporation

A C corporation or “C-Corp” is a separate legal entity from its owners, known as shareholders. The corporation is taxed separately from its owners, and shareholders have limited liability for the company’s debts and legal obligations.

Advantages: C-corps offer some liability protection to their shareholders, which means that shareholders are not personally liable for the company’s debts and legal obligations. (An exception to this limitation would be where someone signs a personal guarantee for a debt or credit.) C corporations can raise capital by selling stocks and can continue to exist even if the ownership or management changes.

C corporations are ideal for businesses that require significant capital investment, such as large manufacturing companies or tech startups. They are also beneficial for companies that plan to reinvest profits into the company, as profits can be retained within the corporation and reinvested in the business without being subject to personal income tax.

Talk to your legal or tax advisor about the benefits of issuing qualified small business stock or “QSBS,” which only C-corps can do.  

S Corporation

An S corporation is a pass-through entity taxed similarly to a partnership. The business is not taxed at the corporate level; the profits and losses are passed through to the shareholders’ personal tax returns.

Advantages: S corporations offer limited liability protection to their shareholders, which means that shareholders are not personally liable for the company’s debts and legal obligations, except as noted above, where a ‘personal guarantee’ is provided to a lender or creditor. 

S corporations avoid double taxation since they are not taxed at the corporate level.

This business structure is ideal for small businesses that want the liability protection of a corporation but also want to avoid double taxation. 

Many tax ramifications of an S-corp need to be considered in light of your personal circumstances. For example, some founders like forming an S-corp where they have outside income and know the new business will lose money in the early years. As a result, they can write off the losses from the S-corp against their other income. 

C-Corp versus S-Corp?  

The factor many founders use to select between a C-corp and an S-corp is taxation. A C-corp is responsible for paying its own taxes based on the financial outcome of the business. The shareholders are not themselves responsible (even though they own shares in the company.)  

In an S-Corp, the shareholders are responsible for paying the taxes attributable to the business results. That can become an issue if you are a minority shareholder in an S-corp that generates significant profits. You will owe taxes on your pro-rata share. However, the S-corp is not obligated to distribute cash to its shareholders to pay those taxes!  

Overall, the decision to choose between a C corporation or an S corporation depends on the specific needs and goals of the business AND your personal circumstances. It’s important to consult with a tax or legal professional to determine which type of business structure is best for your business.

Examples of Business Structure Types used by Entrepreneurs

Samantha, Freelance Graphic Artist 

Samantha is a freelance graphic designer who has decided to start her own design agency. After researching different business structures, she decides to form an LLC. 

Advantages:

• Liability Protection: As the owner of an LLC, Samantha’s personal assets are protected from business liabilities. If the business is sued or faces financial difficulties, her personal assets (like her home or personal savings) are not at risk.
• Tax Flexibility: As a single-member LLC, Samantha can choose to have her business income taxed as a sole proprietorship or as an S-corp, depending on what is most beneficial for her situation.
• Credibility: Forming an LLC adds credibility to her business and makes it more attractive to potential clients.

Samantha chose an LLC because it offers her the personal asset protection she needs as a small business owner and the flexibility to choose how she wants to be taxed. Additionally, forming an LLC adds credibility to her business and gives her a competitive advantage when working with potential clients.

Robert, Website Designer

Robert is a website designer who has recently started his own web design business. After researching different business structures, he decides to operate as a sole proprietor. 

Advantages:

• Easy and Inexpensive: A sole proprietorship is the simplest and least expensive business structure to set up and operate. Robert can start working as a business without having to file any paperwork or pay any fees.
• Complete Control: Robert has full control over his business as a sole proprietor. He doesn’t have to share profits or decision-making authority with anyone else.
• Tax Flexibility: As a sole proprietor, Robert’s business income is taxed as personal income, allowing for greater flexibility in deductions and expenses.

Robert chose to be a sole proprietor because it’s a simple and cost-effective way to start his web design business. He also likes that he has complete control over his business and doesn’t have to share profits or decision-making authority with anyone else. Additionally, being a sole proprietor allows him to take advantage of tax flexibility, which can help him save money and maximize profits.

Paul, Software Company

Paul is an experienced software developer who has decided to start his own software company. After researching different business structures, he decides to form a C-corporation. 

Advantages:

• Liability Protection: Paul’s personal assets are protected from business liabilities as a C-corporation. If the business is sued or faces financial difficulties, his personal assets are not at risk.
• Ability to Raise Capital: A C-corp is the most common structure for startups and high-growth companies that plan to raise outside capital. Investors prefer investing in C-corporations because it allows them to purchase stock in the company and receive a return on their investment in the future.
• Tax Benefits: C-corporations offer tax advantages, such as the ability to deduct employee benefits, as just one example.

Paul chose to form a C-corporation because he plans to raise outside capital to fund his software company’s growth. He knows that investors prefer investing in C-corporations because they can purchase stock in the company and receive a return on their investment in the future. 

Additionally, being a C-corporation provides personal asset protection for owners, which is essential for businesses that may face significant legal or financial risks. Finally, the tax benefits of a C-corporation allow him to maximize profits and reinvest in his company.