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Types of Business Owners Guide: Picking the Right Form

Key Takeaways

  • Understand the different forms of ownership.
  • Comprehend the pros and cons of each business form.
  • Determine the best business scenario for each legal business form.

Starting Your Own Business?

What a skookum idea!

Skookum?!

Chinook Jargon is a slang term originating from the pidgin trade language in British Columbia, Canada, and the Pacific Northwest region of the United States. In this context, ” skookum ” means strong, impressive, or powerful.

While this guide is based on North American businesses (USA and Canada) other Commonwealth countries like Australia, New Zealand, or the UK have similar forms. Still, the regulations, disclosures (franchises), and requirements for forming will slightly differ between these countries. However, the basics covered in this guide should help you get started.

But wait, what form of business should I form? Some people advise me to go with corporations to be protected. Others will say sole proprietorship, as it’s easy. 

How do you choose the right form of ownership?

There are several forms of ownership for businesses, each with its own advantages, disadvantages, legal implications, and business fit. The common forms of ownership include:

  • Sole Proprietorship
  • Partnership
  • Corporation
  • Cooperative
  • Franchise
  • Joint Venture
  • Limited Liability Partnership (LLP)

Each form of ownership has its own legal and tax implications, so it’s essential for entrepreneurs to carefully consider their business goals and consult legal and financial professionals before choosing the most suitable ownership structure. But here are the basics to better inform you before spending too much money on professionals.

1. Sole Proprietorship:

This is the simplest and most common form of business ownership. The business is owned and operated by a single individual, who is personally responsible for all aspects of the business, including debts and liabilities.

What are the benefits of a Sole Proprietorship?

  • Simple and easy to set up and manage.
  • Direct control over business decisions.
  • All profits belong to the owner.

What are the drawbacks of a Sole Proprietorship?

  • Personal liability for business debts and legal issues.
  • Limited access to capital and potential growth.

What are the tax implications of a Sole Proprietorship?

  • The business income is taxed as personal income for the owner.
  • Eligible for small business tax deductions and credits.

What is the best business for Sole Proprietorship?

Small-scale businesses with low startup costs, such as freelancers, consultants, or home-based businesses.

  • Businesses with relatively low liability risks and limited need for external funding.

2. What is a Partnership?

A partnership involves two or more individuals (partners) who come together to run a business. Partnerships can be general partnerships, where all partners share equal responsibility and liability, or limited partnerships, where some partners have limited liability.

What are the benefits of a Partnership?

  • Shared responsibilities and resources among partners.
  • Combines different skills and expertise.
  • Easier access to capital and funding.

What are the drawbacks of a Partnership?

  • Unlimited liability for general partners.
  • Disputes among partners can arise.

What are the tax Implications of a Partnership?

  • Similar to a sole proprietorship, partners’ income is taxed at the personal level.
  • Partnerships must file an information return but are not subject to separate income tax.

What is the best business for Partnership?

  • Businesses that involve two or more individuals with complementary skills and expertise, such as law firms, medical practices, or creative agencies.
  • Joint ventures or projects with defined timelines and objectives.

3. What is a Corporation?

A corporation is a separate legal entity from its owners (shareholders). It provides limited liability protection to shareholders, meaning their personal assets are generally not at risk for the company’s debts. Corporations are more complex to set up and operate, with stricter regulatory requirements, but they offer various tax and financial benefits.

What are the benefits of a Corporation?

  • Limited liability protection for shareholders.
  • Potential for significant growth and access to capital.
  • Perpetual existence even if shareholders change.

What are the drawbacks of a Corporation?

  • More complex and costly to set up and maintain.
  • Stricter regulatory requirements and reporting obligations.

What is the tax implication of a Corporation?

  • Corporate income is taxed at the corporate level, and dividends paid to shareholders are subject to personal income tax.
  • Eligible for certain tax deductions and credits unique to corporations.

What is the best business for a Corporation?

  • Businesses with higher growth potential and substantial financial needs, such as technology startups, manufacturing companies, or multinational corporations.
  • Businesses where limiting personal liability for owners is crucial, especially in industries with higher risk exposure.

S-Corporation

The S-Corporation is a specific business structure available only in the United States and is for small companies with the following restrictions (per the IRS):

  • Be a domestic corporation
  • Have only allowable shareholders
    • May be individuals, certain trusts, estates and
    • May not be partnerships, corporations or non-resident alien shareholders
  • Have no more than 100 shareholders
  • Have only one class of stock
  • Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).

The advantage is that profit/loss can be passed to shareholders for profit sharing or tax deductions. In the past, I did set up my consulting business as an S-Corporation. However, I would not elect that business form if I were a startup in the United States due to the following:

  • Extra Cost
  • Extra Effort
  • Minimal benefit to a startup in most situations

Now, if you’re a startup that will generate income early and want to pay a specific salary (only to be taxed on that salary) and maintain profits to reinvest in growth, then the S-Corporation may be a good choice. With all these business form choices, consulting with an expert is a great idea, and this option can benefit from outside help!

4. What is a Cooperative

A cooperative is owned and operated by its members, who collectively share the benefits and responsibilities of the business.

What are the benefits of a Cooperative?

  • Operated democratically with shared ownership and decision-making.
  • Members benefit from collective resources and profits.

What are the drawbacks of a Cooperative?

  • Complex to establish and manage.
  • Potential challenges in reaching consensus among members.

What is the tax implication of a Cooperative?

  • Members report their share of cooperative income on their personal tax returns.

What is the best business for a Cooperative?

  • Businesses where members have shared interests and actively participate in decision-making, such as agricultural cooperatives, credit unions, or worker cooperatives.

5. What is a Franchise

A franchise is a business model where an individual (franchisee) buys the right to operate a business using the brand, products, and services of an established company (franchisor). Franchisees pay royalties or fees to the franchisor.

Per government regulations, a Franchise is not a legal business form and the owner still needs to choose between the following:

  • Sole Proprietor
  • Partnership
  • Corporation

Refer to the above forms to determine which is the best fit.

What are the benefits of a Franchise?

  • Access to an established brand, products, and support from the franchisor.
  • Proven business model and marketing strategies.

What are the drawbacks of a Franchise?

  • High initial investment and ongoing royalty fees.
  • Limited control over business decisions.

What are the tax implications of a Franchise?

  • Tax implications vary based on the specific franchise agreement and business structure.

What is the best business for Franchise?

  • Businesses that want to leverage an established brand, marketing, and operational support, such as fast-food restaurants, retail stores, or service-based franchises like hotels or car rental companies.

6. What is a Joint Venture

A joint venture involves two or more businesses joining forces to collaborate on a specific project or venture while retaining their individual legal identities. This a more elaborate business form and is subject to many accounting, legal, and other aspects.

For a small business startup, this is beyond the scope of your venture unless you are partnering with a large company, then they will determine much of the terms and conditions of the business form.

What are the benefits of a Joint Venture?

  • Combines resources and expertise of multiple businesses.
  • Allows for sharing risks and costs of a project.

What are the drawbacks of a Joint Venture?

  • Complex to negotiate and manage.
  • Potential for conflicts between partners.

What are the tax implications of a Joint Venture?

  • Tax implications depend on the structure and agreements of the joint venture.

What is the best business for Joint Venture

  • Businesses that are embarking on a specific project or venture with another company, such as real estate development projects, construction contracts, or research and development collaborations.

7. What is a Limited Liability Partnership (LLP):

An LLP is a hybrid form that combines features of a partnership and a corporation. It offers limited liability protection to its partners, shielding them from the actions of other partners. These are generally for service firms like accounting, legal, etc. and the creation of these needs to be carefully crafted wih solid legal and finanial impacts weighed.

If this seems daunting, then likely this is the wrong form for your venture!

What are the benefits of a Limited Liability Partnership (LLP)?

  • Partners have limited liability protection.
  • Flexibility in management and decision-making.

What are the drawbacks of a Limited Liability Partnership (LLP)?

  • Requires more paperwork and formalities than a general partnership.
  • Some professions may not be allowed to form LLPs.

What are the tax implications of a Limited Liability Partnership (LLP)?

  • LLPs are taxed similarly to partnerships, with income flowing through to partners’ personal tax returns.

What is the best business for a Limited Liability Partnership (LLP)?

  • Professional service firms like law firms, accounting firms, or architecture firms have partners who want limited personal liability while maintaining flexibility in management.

Conclusion

It’s important to remember that tax laws and regulations can change, so seeking advice from a qualified accountant or tax professional is essential to ensuring compliance and optimizing tax benefits for your specific business.

In addition, the best fit for a specific business will depend on various factors, including its size, industry, growth potential, risk exposure, and the owners’ preferences. Consulting with legal and financial experts can help you make the most appropriate decision for your particular business venture.

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