the legal structure of a business plan

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How to Choose the Best Legal Structure for Your Business

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Table of Contents

Your business’s legal structure has many ramifications. It can determine how much liability your company faces during lawsuits. It can put up a barrier between your personal and business taxes – or ensure this barrier doesn’t exist. It can also determine how often your board of directors must file paperwork – or if you even need a board. [Related article: What to Do if Your Business Gets Sued ]

We’ll explore business legal structures and how to choose the right structure for your organization. 

What is a business legal structure?

A business legal structure, also known as a business entity, is a government classification that regulates certain aspects of your business. On a federal level, your business legal structure determines your tax burden. On a state level, it can have liability ramifications.

Why is a business legal structure important?

Choosing the right business structure from the start is among the most crucial decisions you can make. Here are some factors to consider:

• Taxes: Sole proprietors, partnership owners and S corporation owners categorize their business income as personal income. C corporation income is business income separate from an owner’s personal income. Given the different tax rates for business and personal incomes, your structure choice can significantly impact your tax burden.
• Liability: Limited liability company (LLC) structures can protect your personal assets in the event of a lawsuit. That said, the federal government does not recognize LLC structures; they exist only on a state level. C corporations are a federal business structure that includes the liability protection of LLCs.
• Paperwork: Each business legal structure has unique tax forms. Additionally, if you structure your company as a corporation, you’ll need to submit articles of incorporation and regularly file certain government reports. If you start a business partnership and do business under a fictitious name, you’ll need to file special paperwork for that as well.
• Hierarchy: Corporations must have a board of directors. In certain states, this board must meet a certain number of times per year. Corporate hierarchies also prevent business closure if an owner transfers shares or exits the company, or when a founder dies . Other structures lack this closure protection.
• Registration: A business legal structure is also a prerequisite for registering your business in your state. You can’t apply for an employer identification number (EIN) or all your necessary licenses and permits without a business structure.
• Fundraising: Your structure can also block you from raising funds in certain ways. For example, sole proprietorships generally can’t offer stocks. That right is primarily reserved for corporations.
• Potential consequences for choosing the wrong structure: Your initial choice of business structure is crucial, although you can change your business structure in the future. However, changing your business structure can be a disorganized, confusing process that can lead to tax consequences and the unintended dissolution of your business. 

If you have to expand your business to another state , you won’t have to create a new company or structure, but you may have to register it as a “foreign entity.”

Types of business structures

The most common business entity types are sole proprietorships, partnerships, limited liability companies, corporations and cooperatives. Here’s more about each type of legal structure.

Sole proprietorship

A sole proprietorship is the simplest business entity. When you set up a sole proprietorship , one person is responsible for all a company’s profits and debts.

“If you want to be your own boss and run a business from home without a physical storefront, a sole proprietorship allows you to be in complete control,” said Deborah Sweeney, vice president and general manager of business acquisitions at Deluxe Corp. “This entity does not offer the separation or protection of personal and professional assets, which could prove to become an issue later on as your business grows and more aspects hold you liable.”

Proprietorship costs vary by market. Generally, early expenses will include state and federal fees, taxes, business equipment leases , office space, banking fees, and any professional services your business contracts. Some examples of these businesses are freelance writers, tutors, bookkeepers , cleaning service providers and babysitters.

A sole proprietorship business structure has several advantages.

• Easy setup: A sole proprietorship is the simplest legal structure to set up. If you – and only you – own your business, this might be the best structure. There is very little paperwork since you have no partners or executive boards.
• Low cost: Costs vary by state, but generally, license fees and business taxes are the only fees associated with a proprietorship.
• Tax deduction: Since you and your business are a single entity, you may be eligible for specific business sole proprietor tax deductions , such as a health insurance deduction.
• Easy exit: Forming a proprietorship is easy, and so is ending one. As a single owner, you can dissolve your business at any time with no formal paperwork required. For example, if you start a day care center and wish to fold the business, refrain from operating the day care and advertising your services.

The sole proprietorship is also one of the most common small business legal structures. Many famous companies started as sole proprietorships and eventually grew into multimillion-dollar businesses. These are a few examples:

• Marriott Hotels

Partnership 

A partnership is owned by two or more individuals. There are two types: a general partnership, where all is shared equally, and a limited partnership, where only one partner has control of operations and the other person (or persons) contributes to and receives part of the profits. Partnerships can operate as sole proprietorships, where there’s no separation between the partners and the business, or limited liability partnerships (LLPs), depending on the entity’s funding and liability structure.

“This entity is ideal for anyone who wants to go into business with a family member, friend or business partner – like running a restaurant or agency together,” Sweeney said. “A partnership allows the partners to share profits and losses and make decisions together within the business structure. Remember that you will be held liable for the decisions made as well as those actions made by your business partner.”

General partnership costs vary, but this structure is more expensive than a sole proprietorship because an attorney should review your partnership agreement. The attorney’s experience and location can affect the cost. 

A business partnership agreement must be a win-win for both sides to succeed. Google is an excellent example of this. In 1995, co-founders Larry Page and Sergey Brin created a small search engine and turned it into the leading global search engine. The co-founders met at Stanford University while pursuing their doctorates and later left to develop a beta version of their search engine. Soon after, they raised $1 million in funding from investors, and Google began receiving thousands of visitors a day. Having a combined ownership of 11.4% of Google provides them with a total net worth of nearly $226.4 billion.

Business partnerships have many advantages. 

• Easy formation: As with a sole proprietorship, there is little paperwork to file for a business partnership. If your state requires you to operate under a fictitious name ( “doing business as,” or DBA ), you’ll need to file a Certificate of Conducting Business as Partners and draft an Articles of Partnership agreement, both of which have additional fees. You’ll usually need a business license as well.
• Growth potential: You’re more likely to obtain a business loan with more than one owner. Bankers can consider two credit histories rather than one, which can be helpful if you have a less-than-stellar credit score.
• Special taxation: General partnerships must file federal tax Form 1065 and state returns, but they do not usually pay income tax. Both partners report their shared income or loss on their individual income tax returns. For example, if you opened a bakery with a friend and structured the business as a general partnership, you and your friend are co-owners. Each owner brings a certain level of experience and working capital to the business, affecting each partner’s business share and contribution. If you brought the most seed capital for the business, you and your partner may agree that you’ll retain a higher share percentage, making you the majority owner.

Partnerships are one of the most common business structures. These are some examples of successful partnerships:

• Warner Bros.
• Hewlett-Packard
• Ben & Jerry’s

Limited liability company 

A limited liability company (LLC) is a hybrid structure that allows owners, partners or shareholders to limit their personal liabilities while enjoying a partnership’s tax and flexibility benefits. Under an LLC, members are shielded from personal liability for the business’s debts if it can’t be proven that they acted in a negligent or wrongful manner that results in injury to another in carrying out the activities of the business.

“Limited liability companies were created to provide business owners with the liability protection that corporations enjoy while allowing earnings and losses to pass through to the owners as income on their personal tax returns,” said Brian Cairns, CEO of ProStrategix Consulting. “LLCs can have one or more members, and profits and losses do not have to be divided equally among members.”

According to Wolters Kluwer , the cost of forming an LLC comprises the state filing fee and can vary depending on your state. For example, if you file an LLC in New York, you must pay a $200 filing fee, a $9 biennial fee, and file a biennial statement with the New York Department of State .

Although small businesses can be LLCs, some large businesses choose this legal structure. The structure is typical among accounting, tax, and law firms, but other types of companies also file as LLCs. One example of an LLC is Anheuser-Busch, one of the leaders in the U.S. beer industry. Headquartered in St. Louis, Anheuser-Busch is a wholly owned subsidiary of Anheuser-Busch InBev, a multinational brewing company based in Leuven, Belgium.

Here some other well-known examples of LLCs:

• Hertz Rent-a-Car

To learn more about LLCs, read our LLC tax guide , our comprehensive overview of starting an LLC , and our guide to creating an LLC operating agreement.

Corporation 

The law regards a corporation as separate from its owners, with legal rights independent of its owners. It can sue, be sued, own and sell property, and sell the rights of ownership in the form of stocks. Corporation filing fees vary by state and fee category. 

There are several types of corporations, including C corporations , S corporations, B corporations, closed corporations, and nonprofit corporations.

• C corporations: C corporations, owned by shareholders, are taxed as separate entities. JPMorgan Chase & Co. is a multinational investment bank and financial services holding company listed as a C corporation. Since C corporations allow an unlimited number of investors, many larger companies – including Apple, Bank of America and Amazon – file for this tax status.
• B corporations: B corporations, otherwise known as benefit corporations, are for-profit entities committed to corporate social responsibility and structured to positively impact society. For example, skincare and cosmetics company The Body Shop has proven its long-term commitment to supporting environmental and social movements, resulting in an awarded B corporation status. The Body Shop uses its presence to advocate for permanent change on issues like human trafficking, domestic violence, climate change, deforestation and animal testing in the cosmetic industry.
• Closed corporations: Closed corporations, typically run by a few shareholders, are not publicly traded and benefit from limited liability protection. Closed corporations, sometimes referred to as privately held companies, have more flexibility than publicly traded companies. For example, Hobby Lobby is a closed corporation – a privately held, family-owned business. Stocks associated with Hobby Lobby are not publicly traded; instead, the stocks have been allocated to family members.
• Open corporations: Open corporations are available for trade on a public market. Many well-known companies, including Microsoft and Ford Motor Co., are open corporations. Each corporation has taken ownership of the company and allows anyone to invest.
• Nonprofit corporations: Nonprofit corporations exist to help others in some way and are rewarded by tax exemption. Some examples of nonprofits are the Salvation Army, American Heart Association and American Red Cross. These organizations all focus on something other than turning a profit.

Corporations enjoy several advantages. 

• Limited liability: Stockholders are not personally liable for claims against your corporation; they are liable only for their personal investments.
• Continuity: Corporations are not affected by death or the transferring of shares by their owners. Your business continues to operate indefinitely, which investors, creditors and consumers prefer.
• Capital: It’s much easier to raise large amounts of capital from multiple investors when your business is incorporated.

This structure is ideal for businesses that are further along in their growth, rather than a startup based in a living room. For example, if you’ve started a shoe company and have already named your business, appointed directors and raised capital through shareholders, the next step is to become incorporated. You’re essentially conducting business at a riskier, yet more lucrative, rate. Additionally, your business could file as an S corporation for the tax benefits. Once your business grows to a certain level, it’s likely in your best interest to incorporate it.

These are some popular examples of corporations:

• General Motors
• Exxon Mobil Corp.
• Domino’s Pizza
• JPMorgan Chase

Learn more about how to become a corporation .

Cooperative 

A cooperative (co-op) is owned by the same people it serves. Its offerings benefit the company’s members, also called user-owners, who vote on the organization’s mission and direction and share profits.

Cooperatives offer a couple main advantages.

• Increased funding: Cooperatives may be eligible for federal grants to help them get started.
• Discounts and better service: Cooperatives can leverage their business size, thus obtaining discounts on products and services for their members.

Forming a cooperative is complex and requires you to choose a business name that indicates whether the co-op is a corporation (e.g., Inc. or Ltd.). The filing fee associated with a co-op agreement varies by state. 

An example of a co-op is CHS Inc., a Fortune 100 business owned by U.S. agricultural cooperatives. As the nation’s leading agribusiness cooperative, CHS reported a net income of $422.4 million for fiscal year 2020. These are some other notable examples of co-ops:

• Land O’Lakes
• Navy Federal Credit Union
• Ace Hardware

The five types of business structures are sole proprietorship, partnership, limited liability company, corporation and cooperative. The right structure depends mainly on your business type.

Factors to consider before choosing a business structure

For new businesses that could fall into two or more of these categories, it’s not always easy to decide which structure to choose. Consider your startup’s financial needs, risk and ability to grow. It can be challenging to switch your legal structure after registering your business, so give it careful analysis in the early stages of forming your business. 

Here are some crucial factors to consider as you choose your business’s legal structure. You should also consult a CPA for advice.

Flexibility 

Where is your company headed, and which type of legal structure allows for the growth you envision? Turn to your business plan to review your goals and see which structure best aligns with those objectives. Your entity should support the possibility for growth and change, not hold it back from its potential. [Learn how to write a business plan with this template .]

When it comes to startup and operational complexity, nothing is more straightforward than a sole proprietorship. Register your name, start doing business, report the profits and pay taxes on it as personal income. However, it can be difficult to procure outside funding. Partnerships, on the other hand, require a signed agreement to define the roles and percentages of profits. Corporations and LLCs have various reporting requirements with state governments and the federal government.

A corporation carries the least amount of personal liability since the law holds that it is its own entity. This means creditors and customers can sue the corporation, but they can’t gain access to any personal assets of the officers or shareholders. An LLC offers the same protection but with the tax benefits of a sole proprietorship. Partnerships share the liability between the partners as defined by their partnership agreement.

An owner of an LLC pays taxes just as a sole proprietor does: All profit is considered personal income and taxed accordingly at the end of the year.

“As a small business owner, you want to avoid double taxation in the early stages,” said Jennifer Friedman, principal at Rivetr. “The LLC structure prevents that and makes sure you’re not taxed as a company, but as an individual.”

Individuals in a partnership also claim their share of the profits as personal income. Your accountant may suggest quarterly or biannual advance payments to minimize the effect on your return. 

A corporation files its own tax returns each year, paying taxes on profits after expenses, including payroll. If you pay yourself from the corporation, you will pay personal taxes, such as those for Social Security and Medicare, on your personal return. 

To simplify payroll complexities and taxation issues, consider using a payroll service. Check out our reviews of the best payroll services to find a partner that fits your needs and budget.

If you want sole or primary control of the business and its activities, a sole proprietorship or an LLC might be the best choice. You can negotiate such control in a partnership agreement as well.

A corporation is constructed to have a board of directors that makes the major decisions that guide the company. A single person can control a corporation, especially at its inception, but as it grows, so does the need to operate it as a board-directed entity. Even for a small corporation, the rules intended for larger organizations – such as keeping notes of every major decision that affects the company – still apply.

Capital investment

If you need to obtain outside funding from an investor, venture capitalist or bank, you may be better off establishing a corporation. Corporations have an easier time obtaining outside funding than sole proprietorships.

Corporations can sell shares of stock and secure additional funding for growth, while sole proprietors can obtain funds only through their personal accounts, using their personal credit or taking on partners. An LLC can face similar struggles, although, as its own entity, it’s not always necessary for the owner to use their personal credit or assets.

Licenses, permits and regulations

In addition to legally registering your business entity, you may need specific licenses and permits to operate. Depending on the type of business and its activities, it may need to be licensed at the local, state and federal levels.

“States have different requirements for different business structures,” Friedman said. “Depending on where you set up, there could be different requirements at the municipal level as well. As you choose your structure, understand the state and industry you’re in. It’s not ‘one size fits all,’ and businesses may not be aware of what’s applicable to them.”

The structures discussed here apply only to for-profit businesses. If you’ve done your research and you’re still unsure which business structure is right for you, Friedman advises speaking with a specialist in business law.

Max Freedman and Matt D’Angelo contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.

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Types of Business Structures Explained

13 min. read

Updated January 5, 2024

The choice you make about what type of business structure is appropriate for your company will affect how much you pay in taxes, the level of risk or liability to your personal assets (your house, your savings), and even your ability to raise money from angel investors or venture capitalists.

So, the structure you choose is significant.

This guide will explain the basics of common business structures, but we can’t tell you exactly which structure you should choose—if you need that kind of advice, you should consult a lawyer or an accountant.

• Sole proprietorship

The simplest business structure is the sole proprietorship. If you don’t create a separate legal entity, your business is a sole proprietorship. 

The main advantage of the sole proprietorship is that it’s relatively simple and inexpensive. The disadvantage is that it doesn’t create a legal separation between you and your personal assets and business assets. If you’re sued or your business folds—your personal assets are fair game for creditors and in terms of legal liability.

Who is a sole proprietorship for?

A sole proprietorship is ideal for self-employed individuals like personal trainers offering individual coaching or artists selling unique items on platforms like Etsy.

Key considerations

• Cost-effective setup: The primary expense is usually the DBA (“doing business as”) registration. Some states may require public notice, like a newspaper ad. Generally, the total cost is below $100.
• Simplified taxation: Sole proprietorships are “pass-through” tax entities. Profits and losses are reported directly on the owner’s taxes, necessitating only a few additional tax forms if you’re the sole worker.
• Hiring employees is possible: Being a “sole” proprietor doesn’t restrict hiring. If you employ others, tax processes become slightly more intricate.
• Limited ways to raise funding: You can’t sell company stock, limiting fundraising avenues.
• Potential loan difficulties: Banks might hesitate to grant loans to sole proprietorships due to perceived credibility issues.
• Full personal liability: If the business faces debt or legal issues, your personal assets, including your home, car, and savings, are vulnerable.

Dig deeper:

Should you register as a sole proprietorship?

Explore the pros and cons of incorporating as a sole proprietorship.

How sole proprietorships are taxed

Understand how registering as a sole proprietor impacts your taxes.

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• Partnerships

Still a relatively simple business structure, a partnership involves two or more individuals sharing ownership of their new business. They’ll contribute to the business in some way and share in profits and losses.

Partnerships are harder to describe because they change so much. State laws govern them, but the Uniform Partnership Act has become the law in most states. That act, however, mainly sets the specific partnership agreement as the real legal core of the partnership so that the legal details can vary widely.

Usually, the income or loss from partnerships passes through to the partners without any partnership tax. The agreements can define different levels of risk, which is why you’ll read about some partnerships with general and limited partners, with different levels of risk for each. Your partnership agreement should clearly define what happens if a partner withdraws, buy and sell arrangements for partners and liquidation arrangements if necessary.

What are the types of partnerships?

• General partnership: Assumes equal involvement of all parties in profits, liabilities, and duties. Any intentional imbalance should be specified in the partnership agreement.
• Limited partnership: Suited for partners in an investor role with limited involvement in daily operations. This structure is more complex and less common.
• Joint venture: Designed for a single project or a limited duration, operating similarly to a general partnership.

Who is a partnership for?

A partnership is similar to an extended sole proprietorship and is ideal for two or more individuals wanting to start a business jointly. 

To make the partnership more effective, you and your partners should have skillsets, connections, or other unique benefits that complement each other. 

For example, a personal trainer and nutritionist building an online fitness program. One entrepreneur has experience building an exercise regiment with clients. The other understands how to create balanced meal and supplement recommendations. 

They have unique but complementary knowledge that, when combined, creates a more valuable product/service.

• Partnership agreement: While not mandatory, it’s advisable to draft a partnership agreement, ideally reviewed by legal counsel, to clarify roles and responsibilities, ownership, and what will happen if a partner wants to leave the partnership.
• Tax implications: Partnerships are “pass-through” entities, meaning profits and losses are directly passed to the partners. Refer to the IRS for partnership tax details.
• Additional costs: Since it’s a good idea to have a lawyer look over your partnership agreement, don’t forget to factor in this added expense.
• Trust in partnership: Ensure your partner is trustworthy, as partners share responsibility for business decisions and debts. A well-drafted partnership agreement can prevent future conflicts.

How to create a business partnership agreement

Even if you’re not in an official partnership, you should consider drafting a partnership agreement. Doing so will clearly define rights and responsibilities and help you amicably resolve any disputes.

How partnerships are taxed

Understand how registering as a partnership impacts your taxes.

Plan for changes with a buy-sell agreement

What will you do if you or your partner quits, sells their portion of the business, or passes away?

How to find the right business partner

A partnership is more than a legal structure. It’s a relationship between entrepreneurs who share a passion for an idea and bring unique skill sets. So, how do you find the right person to make your partnership thrive?…

Traits to look for in a business partner

What makes a good business partner? If you’re considering someone with the following traits, you likely have a good fit.

How many partners should you have?

What’s the ideal number of business partners? The right mix of people and skillsets can lead to tremendous business growth. But too many may lead to disaster.

What to do when your business partner is your life partner

Should your significant other be your business partner? Learn your legal options and how to find the right ownership fit for your business and relationship.

• Limited liability company

Should your business fall on hard times, does the idea of being held personally responsible for all losses sound intimidating?

It’s understandable—plenty of would-be entrepreneurs shudder at the thought of the bank seizing their personal assets should the business go south.

A limited liability corporation (or LLC) is, in some ways, the best of both worlds. It allows for the flexibility of a partnership or sole proprietorship but, as the name suggests, limits the liability of those involved, similar to a corporation. An LLC is usually a lot like an S corporation. It offers a combination of some limitations on legal liability and some favorable tax treatment for profits and transfer of assets.

Who is a limited liability corporation for?

An LLC is ideal for those wary of personal liability in business. If you possess significant personal assets or operate in a lawsuit-prone industry—an LLC safeguards your personal finances. 

• Complexity: While offering more protection, an LLC is harder to establish than a sole proprietorship or partnership.
• Tax benefits: LLCs maintain “pass-through” tax status, meaning you’re taxed only on your profit share, which is reported on personal taxes. 
• Single-member LLCs: Most states allow single-person LLCs, making it a potential alternative to sole proprietorships.

How to form a limited liability company

Interested in forming an LLC? Here are the steps you’ll need to take.

How to create an LLC operating agreement

Set the rules for how your LLC will operate, including the management structure, individual responsibilities, ownership percentage, and other important information.

LLC costs and fees explained

Make sure you’re aware of all the costs and fees associated with forming an LLC.

How LLCs are taxed

Understand how registering as an LLC impacts your taxes.

• Corporations

Shareholders, a more complex legal structure, and more intricate tax requirements are all characteristics of a corporation.

Corporations are either the standard C corporation, the small business S corporation, or the benefit corporation or B corp. The C corporation is the classic legal entity of the vast majority of successful companies in the United States.

Corporations can switch from C to S and back again, but not often. The IRS has strict rules for when and how those switches are made. You’ll almost always want to have your CPA, and in some cases, your attorney, guide you through the legal requirements for switching.

Who is a corporation for?

Corporations are best suited for larger, established businesses with multiple employees, plans for rapid scaling, or intentions to trade or attract significant external investments publicly. A corporation might not be the right choice if you’re a small business owner or work with a small team.

What are the types of corporations?

C corporation.

What we typically think of when we refer to corporations, where all shareholders combine funds and are then given stock in the newly formed business. 

A C corp is a separate tax entity, meaning your business can deduct taxes. It also means that earnings can be taxed twice, as they are concerning your business and your personal taxes if you take income as dividends. However, good tax planning can often minimize the impact of double taxation.

Most lawyers would agree (but verify this with your lawyer who is familiar with your unique business) that the C corporation is the structure that provides the best shielding from personal liability for owners, and provides the best non-tax benefits to owners. Many companies with ambitions of raising major investment capital and eventually going public consider the C corporation.

S corporation

An S corp is similar to a traditional C corporation, with one major difference: Profits and losses can be “passed through” to your personal tax return without being taxed separately first.

In practical terms, the owners can take their profits home without first paying the corporation’s separate tax on profits. In most states, an S corporation is owned by a limited number of private owners (25 is a common maximum), and only individuals (not corporations) can hold stock in S corporations.

To become an S corp, you must first set your business up as a corporation within your state and then request S corp status. The IRS instructions for Form 2553 (which you’ll need to file to become an S corp) can help you determine if you qualify.

B corporation

Does your company have a dedicated social mission, a good cause built into its foundation that you’d like to continue furthering as your company grows? If so, you might consider becoming a B corporation, which stands for “benefit corporation.” 

However, the name is a bit misleading; a B corp isn’t an entirely different structure than a regular C corporation. It’s a C corp vetted and approved for B corp status. Some states give tax breaks to B corps, and it’s a great way to stand behind a cause.

So, why would you choose a B corp over a nonprofit? The biggest difference is in ownership—with a nonprofit, no owners or shareholders exist. A B corp, which is still a type of corporation, still has shareholders who own the company. So, a B corp has a social mission but is still a for-profit company (as opposed to a nonprofit) with an end goal of returning profits to the shareholders.

• Liability: Corporations offer the most protection for personal assets.
• Capital raising: The ability to sell stock enhances investment potential.
• Taxation: Corporate taxes are separate (except for S corps), but the structure can lead to double taxation, especially for C corporations.
• Complexity: Establishing a corporation is more intricate than other business structures, requiring more paperwork and formalities.

How to form a corporation

Follow these ten steps to incorporate as a C, S, or B corporation.

How are corporations taxed?

Understand how registering as a corporation impacts your taxes.

S corporation basics

Should you choose an S corp as the legal structure for your business? Learn the basics and what alternatives are available.

B corporation basics

Should you choose a B corp as the legal structure for your business? Check out this detailed overview of how this business entity functions and the pros and cons you’ll contend with.

A nonprofit is a “not-for-profit” business structure, meaning the business does not exist to generate revenue for shareholders, but rather funnel business revenue into a social mission, cause, or purpose.

Who is a nonprofit for?

Nonprofits cater to those with missions centered on charitable, educational, scientific, or religious purposes. Examples include homeless shelters, conservation groups, arts centers, and educational institutions.

What’s the difference between a nonprofit and a cooperative?

Like a nonprofit, a cooperative is a business with a social mission that doesn’t divide income between shareholders but toward a cause or purpose. However, while some states view nonprofits and cooperatives as the same, a cooperative differs because the members own it, referred to as “user-owners.”

If you plan on organizing your business to be democratically owned, looking into the cooperative business structure might be a good idea to look into the cooperative business structure .

• Complex setup: Establishing a nonprofit requires steps similar to forming a corporation, including filing articles of incorporation, creating bylaws, and organizing board meetings.
• Fundraising will be your main priority: Nonprofits generally rely on fundraising and grants to keep a flow of income into their business.

What is a nonprofit corporation and how to start one

Learn the basics of setting up a nonprofit corporation.

How to earn income as a nonprofit corporation

Learn how related and unrelated business activities can generate revenue for a nonprofit corporation.

• Making your business legally compliant

Choosing a business structure is the first legal step you’ll take. Your choice will impact your taxes, fundraising, and personal liability. 

Tim Berry, founder of Palo Alto Software (maker of Bplans) reminds small business and startup founders that choosing a business entity or structure is something to take seriously. He says:

“Make sure you know which legal steps you must take to be in business. I’m not an attorney, and I don’t give legal advice. I strongly recommend working with an attorney to review the details of your company’s legal establishment and licensing. The trade-offs involved in incorporation versus partnership versus other structures are significant. Small problems developed at the early stages of a new business can become horrendous problems later on. In this regard, the cost of simple legal advice is almost always worth it. Don’t skimp on legal costs.”

TLDR: Take time, carefully weigh your options, and consult a legal professional.

Once you’ve chosen, check off the remaining legal requirements to start a business. While you can complete most of these in any order, here are a few suggestions.

• Apply for a federal and state tax ID
• Obtain licenses and permits
• Register your business name

Clarify your ideas and understand how to start your business with LivePlan

Kody Wirth is a content writer and SEO specialist for Palo Alto Software—the creator's of Bplans and LivePlan. He has 3+ years experience covering small business topics and runs a part-time content writing service in his spare time.

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Sole Proprietorship

Partnership, limited liability company (llc), corporation, templates and examples to download in word and pdf formats, how to choose the best legal structure for your business.

Deciding on a specific type of legal structure when you've just started your business journey can be complicated. It's hard to know exactly what the differences are, how the different structures can benefit you, and what any risks might be.

Luckily, it doesn't have to be so complicated! In fact, we've published this guide on everything you need to know about choosing the right legal structure for your business to help you along the way.

The most common business structures are sole proprietorships, partnerships, limited liability companies, and corporations. Here, you'll learn about each one in detail to help you choose the right fit for your business, as well as a non-profit, which you might consider for a new charitable business.

What type of structure you choose will make a big difference over the life of your business. It can have significant tax implications, as well as implications for your personal level of risk. It is not a decision that should be made lightly.

Below, we examine each common business structure in detail.

A sole proprietorship is the simplest type of business structure and the easiest to form and maintain. A sole proprietorship is basically a business that is you - and you are the business! For example, if you were a freelance writer on the internet and wanted to operate as a sole proprietorship, you wouldn't have to do anything at all to already be up and running, as long as you wanted to operate under your name.

In a sole proprietorship, no separate legal entity is created. If you'd like to operate under a special name, like a new business name or just a different name other than your own legal name, you would file what is called a "Doing Business As" (or DBA, as it is referred to) document with your state. All this document does is tell the state that you, as a legal person, are doing business under the name you've chosen for your business.

Because of the simplicity of the sole proprietorship, the way that your taxes are handled is also fairly simple. The taxes of the sole proprietorship would "pass through" to you, meaning you report any profit or loss on your own taxes and don't have to go through a separate process for the business.

One of the biggest drawbacks to a sole proprietorship is that you can be personally on the hook for any business liabilities - whether you make a big financial loss one year or whether your business gets sued. That's because in a sole proprietorship, there is no separation between you as a person and you as a business, so anything you own, in terms of assets, may be up-for-grabs by any creditors or the public to whom you are facing liability.

Another big drawback is that you may have a hard time raising any money. In a sole proprietorship, you can't issue stock in the company, so it could be hard to attract capital investors. You also may not have much success getting a bank loan, because banks generally don't favor lending to sole proprietorships.

How to form a sole proprietorship

To create a sole proprietorship, as mentioned above, you wouldn't have to file anything with your state other than a DBA, if you'd like. There can be fees associated with the DBA form, which vary per state. But keep in mind you might have separate documents to file, depending on your business. These could include special licenses or permits.

Why you might choose a sole proprietorship

A sole proprietorship is a good idea if you are a solopreneur with a small business and you are planning to keep it that way. It's very easy to form (you either have to file no documents or just one DBA) and you can get focused on starting your business right away. It's also very cheap to get started.

Especially if your business may not be facing a high level of risk, a sole proprietorship might be for you. A sole proprietorship wouldn't be recommended if, let's say, you ran a business that dealt with large amounts of other people's money on a regular business, or as a health professional, or really any area where the risk of being liable for something serious is high.

Final overview

Sole proprietorship benefits:.

1. It's cheap and easy to form.

2. Taxes are easy to keep track of.

3. You still have the option to have employees if you would like.

Sole proprietorship drawbacks:

1. There is a high level of personal risk for liabilities.

2. You may have difficulty raising funds.

If a sole proprietorship is the simplest business structure for an individual looking to operate their own small business, a partnership might be considered that for two or more people.

In a partnership, the two or more "partners," as they are called, each generally have a say in how the company runs (depending on the structure of the partnership) and each own a piece of the company, including its profits and losses.

In a partnership, you can also have different types of partners - general partners and limited partners - or you can have just a general partnership with all the same types of partners. General partners are equally responsible for everything: all the profits, any potential losses, any liabilities that might come up, and general responsibility for the company, including the amount of work done. Limited partners are those that are basically only partners for a financial reason, in that they invest but have not much else to do with how the company runs. Overall, partnerships with limited partners are a little rarer, as people like to go into partnerships with equal weight.

Imagine a situation where two people decide to open a yoga studio together. Their structure of choice may be a partnership.

A joint venture, formed with a Joint Venture Agreement , is a type of general partnership that only lasts for one specific project or a limited amount of time.

Joint venture is a generic term for any business relationship between two parties for a limited time. A joint venture could be for a brand new business, or just one marketing promotion, or even just a project between two already-formed businesses. In a joint venture, the parties could decide to form a temporary partnership, with a Partnership Agreement , but they don't have to: they can also retain their fully separate legal identities and just operate with a Joint Venture Agreement.

Taxes in a partnership can pass through, just like in a sole proprietorship.

The formation of a partnership, however, can be very complicated. Many states have adopted something called the Uniform Partnership Act, which makes the written Partnership Agreement very important. Partners will need to figure out everything from how they'll run the day-to-day business to what happens if the business folds or if someone wants to leave.

The Uniform Partnership Act is similar to a model statute or model law, in that it was drafted to be applicable uniformly, but states each had to individually adopt it. The Uniform Partnership Act, or UPA, gives guidance on how business partnerships should be formed, governed, and dissolved.

How to form a partnership

As mentioned above, the basis of partnership formation is the written Partnership Agreement, which sets out all of the details of the business relationship between the parties. Unless you also want to file a DBA, you won't need to file any partnership documents with your state.

Keep in mind, however, that as above, you may need specific licenses or permits for your particular business model.

Why you might choose a partnership

A partnership is a good idea if you are running a small business with another individual or a few individuals. As with a sole proprietorship, it's very easy to form (you either have to file no documents with the state or just one DBA) and you can get focused on starting your business right away. It's also very cheap to get started, just like a sole proprietorship.

If you're not sure of the trustworthiness of your potential partners, however, a partnership may not be the way to go for you, as you could be exposing yourself to a high level of risk just because of the actions of your partners. Either way, however, you should always have a well-written Partnership Agreement in place.

Partnership benefits:

1. It's relatively cheap to form.

2. Generally, unless you have a DBA, you won't need to file with the state.

3. Taxes pass through.

Partnership drawbacks:

1. The Partnership Agreement can be a complicated document.

2. It can be very risky if your partners are not trustworthy.

A Limited Liability Company, or LLC for short, has largely become the preferred form of structure for many small- to medium-sized businesses, and even for a lot of solo business owners. The reason for this is because it has a lot of benefits of other types of business structures, without as much of the risk.

In an LLC, there is a lot of customization available for how the business is run. LLCs can be used for small businesses or large ones. You can form an LLC just for yourself or have an LLC with many different members. The main benefit of an LLC is that your personal assets are shielded from liability - hence the name, "limited liability" company.

Taxes still pass through in LLCs. If you are a single-member LLC, the taxation is similar to a sole proprietorship. In a multi-member LLC, you are taxed on just your portion of the profits.

LLCs can, therefore, be formed for almost any purpose - for a single freelance artist or a group of people looking to open a bakery together, for example. LLCs can even be formed for professionals, like a legal or medical practice.

Since all business structures are formed according to the state, and not federal, government, the requirements to file and run the business, especially for the more complicated structures, can vary.

Forming an LLC is more complicated than either a sole proprietorship or partnership, as it involves filing specific documents in a specific form with the state.

How to form an LLC

An LLC is generally filed with your state by drafting Articles of Organization , the creation document for the company. Before this, you'll also have to ensure that you have a business name that will work by running a search on your proposed business name with your state's Secretary of State (usually this can be done easily on the Secretary of State website). An Operating Agreement is also a very good idea to have drafted (though it is not required), especially if you have more than one LLC member.

If you would like to operate under a special name for your LLC, you may also have to file a DBA.

Why you might choose an LLC

An LLC is a good idea when you want to have the maximum amount of liability protection for your business, either as a solo business owner or as part of a team and you don't want to build a corporation (more on that below). It's also a good idea if you still want the simplicity of taxation and the ability to organize your business as you like.

Whenever you file your LLC, make sure you keep all of the records separate to ensure your liability protection. Your organizational records, banking records, and, if applicable, personnel records all need to be records of the LLC specifically, not mixed in with your own personal records.

LLC benefits:

1. You are protected from personal liability.

2. Taxes pass through.

LLC drawbacks:

1. It's a little more expensive and complicated to form than a sole proprietorship or partnership.

2. Your liability is subject to the separateness of all of your records.

A corporation is generally the most complex legal structure , involving a lot of time and resources at its formation and then on through its life. A corporation is its own separate entity - often sometimes compared to a business version of a legal "person." In other words, the corporation is its own body separate and apart from you or any of the other owners, called "shareholders."

A corporation can take one of three main forms: the C corporation, the S corporation, or the lesser-known B corporation.

Most big companies in the United States, like Fortune 500 companies, are organized into a C corporation. It's the "traditional" corporate structure that people think of when they think of corporations. In a C corp, there are owners, called shareholders as noted above, who all put money into the business and receive shares, or stock, in return. The corporation gets taxed on its own - but so do any shareholder earnings, which means that with corporations, there is what's called "double taxation." All that means is that money into the corporation gets taxed as does money to the shareholders. In a C corp, there is almost no personal liability of the shareholders. Additionally, there is the possibility of the shareholders earning a lot of income if the corporation ever goes public.

The S corporation is a slightly different entity, similar to the C corp, but with the possibility of pass-through taxation. As discussed in the other business forms, what this means is that profits and losses can go straight to the owner or owners of the S corp, making it a good idea for small businesses. The S corp is a little more limited than the C corp in most states, however, as it can usually only be held by a certain limit of private individuals (for example, up to 25 owners that all have to be real people, rather than legal entities).

A B corporation is a lesser-known structure than the others and that's because it won't be applicable to most people. B Corps are designed for those that want to form essentially a C corporation but for some social good. The B stands for "benefit." A B Corp is very similar to a C Corp, except that sometimes the corporation receives certain tax breaks.

How to form a Corporation

Corporations are formed by filing a significant document covering the details of the corporation with the Secretary of State, called the Articles of Incorporation . Most corporations need to have a viable business name and go on to obtain a tax identification number from the Internal Revenue Service.

It's a good idea to also draft a document called the Corporate Bylaws , which set down the governing rules for the corporation.

Why you might choose a Corporation

You might decide to file a corporation if you are looking for a lot of growth potential for your business or if you knew you wanted to start bringing on shareholders right away. A corporation is a good idea if you plan to hire a lot of employees, as well.

It's probably not a good idea for very small business or individuals who don't plan to grow at a very high rate, as the expense of setting up and maintaining the structure, as well as the double taxation, would easily make it more cumbersome than its worth.

Corporation benefits:

2. Raising capital may be easier here than any other business form.

Corporation drawbacks:

1. It's more expensive and complicated to form than any other business form.

2. It's also complicated and expensive to maintain.

3. Double taxation may end up costing you more.

A non-profit is different than all of the other business structures - and the difference is in its name. Non-profits are created for a different reason than just generating profit; usually, the reason is some kind of social cause.

Non-profits are tax-exempt entities, and because of this, they need to have a specific purpose that is either charitable, religious, or educational.

How to form a Non-profit

Forming a non-profit requires Articles of Incorporation with the Secretary of State. You'll then need to file specifically to obtain tax-exempt status from both your state and the federal government.

If you plan to have multiple people in your non-profit, drafting Non-Profit Bylaws is a good idea.

Why you might choose a Non-profit

The option for a non-profit is really only there if you have a business that is for charitable, religious, or educational purposes. Once you decide that you do, then you must ensure you really aren't running a business for profit and that the primary purpose is for another reason. If those requirements are met, the non-profit is the best choice for you.

If you'd like to run a business for a social cause, but still want to have the main goal of earning a profit, a B corporation might be better suited to your needs. With a non-profit, one of the main activities will simply have to be fundraising to keep the business afloat. In a B corporation, however, you can do good and still turn a profit.

Non-profit benefits:

1. Tax-exempt status can be obtained.

2. It's the best structure for any primarily charitable business.

Non-profit drawbacks:

1. You must meet the requirements to open a non-profit.

2. Your business can't be run primarily to earn a profit.

When deciding what type of structure might be best for you, ask yourself the following questions:

1. How much time and effort am I willing to put in to set up the business at the beginning?

2. How much time and effort am I willing to put in to maintain the business over time?

3. Is pass-through taxation important to me?

4. What will be personal liabilities be?

5. Am I interested in easily raising capital?

Once you've asked yourself these questions, with the knowledge obtained from this guide, you'll be in a great place to decide what the best structure is for your needs.

About the Author: Anjali Nowakowski is a Legal Templates Programmer at Wonder.Legal and is based in the U.S.A.

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Determine the Legal Structure of Your Business

Free Small Business Partnership Contract Template

Radhika Agarwal

• December 13, 2023

13 Min Read

Consider the following situation: You have a brilliant business idea and have planned your business down to the last detail. You are most probably ready to get going. But, hold on. Did you choose a legal business structure? If not, you might want to decide the same before starting out.

Though picking an option amongst several similar-looking ones might seem intimidating at first, picking the right one can save your business from several legal hassles later on.

A proper legal structure decides whether you’ll stay on the good side of the law or not, both literally and figuratively.

Want to know how? Follow along to find out.

Why Does the Legal Structure of a Business Matter?

Against popular belief, a legal structure not just decides the taxes you’ll pay. It also decides the level of risks to your personal assets (your personal savings, car, house, etc.) and your business’s ability to raise funds through loans and investments .

Going through all of your options can help you decide which one fits the best for your business. Moreover, it also helps you finalize if you would need an attorney’s help or not.

So, if you want to get a quick overview of what different types of business structures would look like, read on.

What Are Different Types of Business Structures?

Depending upon the type of ownership, liability on personal assets, and size of the firm, the following legal structures exist in the US:

Sole Proprietorship

Partnership, corporation.

Suppose you plan on selling artwork, retail products, or any product or service under the sun for that matter. Also, you want to go through as little paperwork and legal procedures as possible.

Then a sole proprietorship might be for you. Especially, if you plan on starting the business under your name, you might not have to do any paperwork at all.

Even if you want to have a domain name , registering your domain name would be the only legal procedure you’ll have to go through. And that’s fairly simple and inexpensive.

Hence, a sole proprietorship is a perfect business structure type for those who have a product or service and wish to start selling it right out.

How to form a sole proprietorship?

A sole proprietorship is fairly simple to form. If you have your business idea and plan sorted, you can start your business. Without any official registration or legal framework whatsoever.

Although you should keep in mind that depending upon your industry you might need to get some licenses and permits before you start.

If you are doing business under a name other than your own, you would also have to get a DBA or “ doing business as.”

A sole proprietorship has the following advantages:

• Easy to set up: A sole proprietorship is fairly easy to set up and involves little or no legal hassles.
• Relatively Inexpensive: Setting up a sole proprietorship is the cheapest of all legal structures. All you have to pay is a small fee for a business license and business tax depending upon the location of your business .
• Dissolution is easy: As your business has no stakeholders except you, the dissolution can happen without any disagreements or problems.
• You are the sole benefactor of profits and sole bearer of losses: Your profits belong only to you and you aren’t answerable to anyone for your losses.

Disadvantages

Although sole proprietorship might look like a great option right now, it has its fair share of disadvantages too. Which are as follows:

Liability on your assets: As you and your business are a single legal entity, if things go south your personal assets would be in danger. i.e., you’ll have to pay the debts incurred through your business using your personal assets.

Difficulty in raising capital: It is tougher for sole proprietors to acquire a small business loan or funding. Banks are often less willing to give loans to sole proprietors as they are considered less credible. Also, you cannot sell stocks to generate funds as a sole proprietor .

Limited tax savings: Sole proprietorships do not get tax benefits like corporations do for offering benefits like medical reimbursements and insurances to their employees.

Suppose you are an architect and want to start a firm with your friend who’s an interior designer.

Depending upon the ratio of contributions you make towards the working of the firm you’ll have a certain share in profits and losses of the firm.

It can either be equal or 40 to 60, etc. Also, the size of contributions can be measured both by the size of your investments or the amount of work you provide.

For example, if your friend has invested a higher sum of money but you work more. So, chances are that your ratio in profits would be equivalent.

Apart from that, a partnership is a lot like a sole proprietorship but instead of being the sole owner of the business, you have a partner.

Your partner would have a predetermined share in the profits and losses of your firm.

How to form a partnership?

Just like a sole proprietorship a partnership is fairly simple to form. The only difference is a partnership agreement .

Having a partnership agreement is crucial to this business structure type. A lot of things can go haywire if you don’t work on pre-decided terms and conditions.

Your partnership agreement would decide your share in profits and losses, the type of partnership you have, and what would happen if you decide to dissolve the partnership in the future.

Types of partnership

A partnership can be of the following types:

• General Partnership: In a general partnership, all the partners have an equivalent stake in the business.
• Limited Partnership: A limited partnership has partners who play the role of an investor and have no say in the functioning of the business.
• Joint Venture: A joint venture is a partnership that exists for a limited period or for certain projects.

The advantages of a partnership can be given as follows:

Easy to form: Just like a sole proprietorship, a partnership is fairly easy to form. And requires a very little amount of legal procedures.

Has more growth potential: As a partnership combines the strengths and talents of all partners, it has more growth potential than a sole proprietorship.

Moving forward without a partnership agreement can be disastrous: You shouldn’t move forward without a proper legal agreement . There are a lot of things that can go awry without one. And coming to terms with an agreement that suits everyone is difficult for a lot of partnerships.

Unlimited liability on your personal assets: Just like a sole proprietorship, there’s an unlimited liability on your personal assets. In such structures, you can lose your personal belongings if your business fails.

Difficulty in dissolution: Dissolution is tougher in partnerships as the business has multiple stakeholders.

Consider the following situation: You want to start a business but have a significant amount of personal belongings that you don’t want to risk.

Then an LLC or a limited liability company might be for you. In an LLC you are taxed only on your profits.

Also, there’s no liability on your personal assets as you and your business are separate legal entities.

An LLC is a fairly new legal structure and is good for industries where lawsuits are common. Moreover, an LLC gets the best of both worlds.

Its tax structure is like a partnership and it has a limited liability structure like a corporation.

Also, unlike a corporation, an LLC can be set up by smaller businesses too.

How to form an LLC?

An LLC is formed by creating a separate legal entity for your business. Although it requires way more paperwork than a sole proprietorship or partnership, it is a more secure structure than either of those.

And you might think that a little paperwork is worth the benefits it provides. And it definitely is! You can form an LLC either on your own or with a partner.

The specific amount of paperwork required for an LLC varies from state to state.

Your personal assets would be safe: One of the major benefits of any limited liability structure is that your personal assets remain unaffected if things go downhill.

The tax structure is beneficial: You are only taxed on your profits in an LLC.

An LLC is tougher to set up: It is comparatively more expensive and complicated to set up. You might have to take some legal advice as well before you set up an LLC.

An LLC has to be dissolved within 30 years: An LLC has to be dissolved in 30 years or less, depending upon your pre-decided agreement. Although, all states have different laws regarding the dissolution of an LLC.

Corporations are one of the most commonly known types of business structures out there. They are usually larger, have more employees, and take the highest amount of legal work to set up.

The biggest advantages of a corporation are its limited liability structure and the tax benefits it gets.

Most of the bigger companies and MNCs follow this structure, but if you have a small business it is neither possible nor feasible to have such a structure. Though, a lot of LLCs and partnerships turn into corporations as they grow bigger.

How to set up a corporation?

Setting up a corporation requires the highest amount of paperwork and legal procedures.

You have to register your business name and get your EIN or employer identification number, etc.

Also, depending upon your state and type of corporation the legal procedure for setting up a corporation would differ.

Types of corporation

A corporation can be divided into the following types depending upon its size and functions:

A C Corp is the most common type of corporation out there. Most MNCs follow this structure.

To form a C Corp you collect fundings and give stocks equivalent to the funding to your investors.Although double taxation might be a problem, C Corp has the highest opportunity of getting investments. Hence, most companies follow this structure when they go public. For example, if you are a corporate firm with a large number of employees and investors, you’ll follow this structure. Microsoft, Intel, and Apple are popular examples of C Corps.

An S Corp is a pass-through tax entity and is usually owned by families or small groups.

Also, the motive of a C Corp is to grow big and go public, while an S Corp exists to generate profits for its owners. Hence, both the structures fulfill different motives for their owners. An S Corp is very similar to an LLC and is a structure that can be followed by small businesses. A lot of S Corps turn into C Corps as they grow bigger. Apart from that, people choose this structure mainly for the tax benefits it offers.

For example, organization XYZ works towards the social and economic upliftment of underprivileged children. But at the same time, it has investors to whom it has to send back profits. Hence, XYZ organization is not a non-profit but a B Corp. A B Corp is an excellent way of standing behind a social cause and many states provide tax benefits to such structures. Ben & Jerry’s, Seventh Generation, and Etsy are popular B Corps in the US. If we try to understand this further through the example of Ben and Jerry’s, the company has three main motives- product quality, economic reward, and service to the community. Because Ben and Jerry’s is a for-profit company that stands behind a cause it becomes eligible for its B Corp status.

The most limited possible liability: Corporations give the highest amount of protection to your personal assets. If things go awry, your personal assets will be the safest in this structure.

Corporations have a high potential to raise capital: With the option of selling stocks to get funding and more credibility to get loans, raising capital is fairly easy for corporations.

Taxes are filed separately from personal taxes: As taxes are filed separately from personal taxes in corporations your business becomes eligible for corporate tax breaks.

Difficult to set up: Corporations go through way more procedures, legal or otherwise and are fairly difficult to set up. The structure is also not an ideal one for smaller businesses.

Double taxation: You have to pay taxes on both the earnings of the corporation as well as on the dividend you get from it. This disadvantage mainly holds true for a C Corp.

If you want to work towards a social cause and channel all your energies towards it, a non-profit organization would fit the best for you.

The chief difference between any other legal structure and a non-profit is that a non-profit solely exists for fulfilling a social cause and not for earning profit.

Such organizations get tax-exempt status from the government.

As a nonprofit is run for serving society and for personal values, it does not have any advantages or disadvantages as such.

But you should keep the following things in mind before starting a nonprofit organization :

• Your setup will be similar to that of a corporation: You’ll have to register your business’s name as well as your taxation number as a non-profit to get tax exemptions.
• You should have a solid system in place to collect funds: If you choose this business structure, generating funds to keep your firm going will be a chief priority.

In conclusion, the legal structure of a business plan greatly depends upon the said firm’s function and size. The number of legal formalities you are able and willing to fulfill, the laws of the state your business will function from, and so on.

Also, getting legal advice from an attorney while deciding your structure can be of great help for your business. A little expense and effort, in the beginning, can take your business a long way in the future.

Your legal structure would impact a lot of aspects of your business. Hence, you should choose it wisely.

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About the Author

Radhika is an economics graduate and likes to read about every subject and idea she comes across. Apart from that she can discuss her favorite books to lengths( to the point you\'ll start feeling a little annoyed) and spends most of her free time on Google word coach.

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• How to Draft an Effective Business Plan Considering the Legal Implications

The road to the creation of a new business is a long one that is often filled with unexpected challenges and accomplishments. While the unpredictable nature of starting a business can be appealing to some, for many there is value in developing a plan to help guide new owners through the first months and years of operation. For this reason, one of the most important steps that entrepreneurs can take when starting out is to carefully and thoughtfully develop a comprehensive business plan.

What Is a Business Plan?

A business plan is both a map and a marketing tool for your business. A business plan helps you carefully set forth the purpose, goals, and priorities of your new business, along with guideposts to help ensure that you stay on the right path. For instance, a business plan may require you to consider what the primary purpose of your business is, or the good or service you intend to provide, who your potential customers are, and how you intend to reach them in an effective and efficient manner. A business plan also allows you to make an honest evaluation of the current status of your business and what you will need to do to get to where you would like to be. This includes taking the time to compile your business balance sheet, analyze existing income and expenses, and determine anticipated financial needs.

Creating a detailed business plan can help business owners acquire outside funding .

In addition, a business plan serves as a marketing tool for new business owners who are attempting to gain financial backing, operational support, or mentoring for their new business. The financial aspects of a business plan lets potential funders or lenders analyze your current income streams and the likelihood of repayment, while the detailed explanation of your business objectives and operational plans helps to convince interested parties that you have taken the time to carefully plan your business endeavors and are invested in the success of your company.

How to Write a Business Plan

There is no one specific way to write a business plan. However, there are key components that most business plans should include, and these are good starting points when working on your own plan. It may also be worth reaching out to an experienced corporate attorney to help you review and revise your business plan before presenting it to others in the business community.

Business plans typically start with a summary of the business and its objectives, and then they describe the operations of the business, the good or service it will be providing, and potential income streams in more detail. Business plans should also include a detailed description of the proposed management structure of the business, including officers or directors and possibly the envisioned composition of the board. Additionally, business plans typically include extensive financial documentation, such as balance sheets, income projections or growth model projections, any pending loan applications, tax returns of the entity, and copies of any relevant legal agreements. If the business has already been in operation for some time, the business plan may also include financial records for the months of operation.

• Summarize the business and its objectives
• Outline how the business is organized and managed
• Describe what the business sells
• Identify potential income streams
• Include financial information, such as balance sheets and projections

Using Your Business Plan

Once you have completed a business plan that you are happy with, you will find that you will often continue to refer to your plan even months or years after it was initially completed. In the initial stages, you can use your business plan to attract investors, partners, board members, or other advisors who are interested in the model you have proposed and would like to contribute to its success. As your business develops, you can continue to refer to the plan to guide you in business decisions, as well as to track timelines or certain goals that you hoped to meet. Even after your business is well-developed, returning to your business plan can help guide your yearly planning for your company, allowing you to modify your goals as they are achieved.

Last reviewed October 2023

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• Building Your Business
• Becoming an Owner
• Business Types

Business Legal Organizational Structures

Choosing a business structure, a sole proprietorship.

• General Partnership

A Limited Partnership

• Limited Liability Partnership (LLP)
• Limited Liability Company (LLC)

A C Corporation

An s corporation.

• Non-Profit Corporation

Professional Corporations, Professional Associations, and Professional LLCs

Frequently asked questions (faqs).

Klaus Vedfelt / Getty Images

Choosing the proper legal, organizational structure for your business is one of the most important decisions you'll make. It might not have much of an impact on the day-to-day operations of a small business, but it can have a huge impact come tax time, when you want to borrow money or attract investors, or in the unfortunate event that you're sued or taken to court.

It's possible to change your structure at a later date, but it can be a difficult and expensive process. It's best to make the right decision in the first place, but you have to understand how each structure works in order to do that. These are the basic forms of business ownership available to you in the United States.

Key Takeaways

• A sole proprietorship is the simplest kind of business structure to form, but it leaves its owner without legal protections against business liabilities.
• There are three basic types of partnership structures, each with its own pros and cons.
• Most corporations are either "C" corporations or "S" corporations, but there are other types of this business structure as well, depending on your goals and needs.
• The rules for business structures can vary from state to state, so be sure to check with your state's Secretary of State Office for the exact details and requirements in your location.

There are many choices and factors to consider when you're setting up the structure of your business. Many of the advantages of incorporating can be gained in other ways for sole proprietors, such as purchasing liability insurance. And the paper legalities are often outweighed by real-world practicalities. 

For example, a corporation shields its owners from personal liability for its debts, but it's unlikely that you'll even be able to get business credit during the first two to three years. at least without personally co-signing as a guarantor. And you'll forfeit that protection if you do so.

The major advantage of a sole proprietorship is that it's the simplest and least expensive structure to form. There's really nothing to set up and maintain, except perhaps a fictitious business name, referred to as a DBA, or "Doing Business As " name.

An individual owner of an unincorporated business operates the business as an extension of themselves. The profits and losses of the business are reported on the tax return of the owner, and that owner is personally responsible for any liabilities of the business. A court can directly levy the personal bank account and other property of the owner if anyone successfully sues the business for breach of contract, personal injury, or to collect a debt.

A General Partnership 

An advantage of a partnership is that, like a sole proprietorship, no state filings are required to create the business entity. Nor are there any ongoing reporting requirements.

Two or more people own the business jointly in a general partnership. They share the profits and losses of the business as spelled out in the partnership agreement . Each partner is potentially responsible for the full amount of the business's liabilities. A creditor of the business can collect the full amount of a partnership debt from the partner that's easiest to collect from. 

Distribution of profits and losses is determined by the partnership agreement and passes through to the individual partners. It doesn't have to match the ownership percentages. The partnership itself isn't subject to any income or franchise tax.

Control of a general partnership is determined by the partnership agreement. The partners control the business jointly unless stated otherwise, with each partner having an equal vote. 

The basic structure and tax implications of a limited partnership are the same as for a general partnership, but a limited partnership allows for one or more limited partners called "silent partners" to own a portion of the business. Silent partners can't participate in the management of the business.

This type of partnership must also have a general partner who has personal liability for all liabilities of the partnership. This structure allows a partnership to have outside investors without subjecting them to the liabilities of the business.

A Limited Liability Partnership (LLP) 

The LLP came about as a result of demand from attorney and accounting firms who wanted to be able to limit the liability between partners. These firms were not allowed to incorporate at one time. An LLP is taxed like a partnership, but it limits the liabilities of all partners, much like an LLC.

Limited liability partnership laws can vary significantly from state to state. California and New York allow this form of business structure only for attorney and accounting firms. Partners in an LLP only have a "limited shield" in other states and aren't afforded the same protection they would enjoy in an LLC or corporation .

These restrictions generally make an LLP a good choice only for attorney and accounting firms, at least in states with the limited shield law. Check with your ​Secretary of State for the specifics in your location.

A Limited Liability Company (LLC) 

An LLC is a hybrid of a corporation and a partnership, and it's rapidly becoming the most popular structure for small businesses due to its flexibility. Its cost to create and maintain is low, while it still offers most of the advantages of a corporation. The ownership percentages, profit and loss distributions, and voting powers of each member are determined by the LLC Articles of Organization, rather than by stock ownership. 

An LLC can choose to be taxed as a partnership or as an S Corporation with profits and losses flowing through to the owners’ tax returns, or taxed as a C Corporation, filing its own return. The owners, officers, and directors are protected from the liabilities of the company, as in a corporation.

An LLC is generally subject to the franchise tax, though this varies from state to state.

The term "corporation" generally refers to a C corporation. A corporation is owned by one or more stockholders. It's managed by a board of directors who are elected by the stockholders and it's run day-to-day by officers who are appointed by the board of directors. A single individual can be the sole stockholder, director, and officer of the company.

The stockholders , directors, and officers are protected from the liabilities of the company, including liabilities for their own negligence when acting in their corporate role, except in certain extraordinary circumstances.

The profits and losses of the corporation typically are not passed through to the tax returns of the owners. The corporation files its own tax return and it pays its own taxes. It may also be subject to state franchise taxes or other annual fees. Corporate income tax rates are graduated based upon the taxable income as they are for individual taxpayers, but the rates and levels of the brackets are different.

The Stockholders can elect "S Corporation" status after the corporation has been formed by making a filing with the IRS. An S Corporation is taxed as a partnership, and its profits and losses flow through to the federal tax returns of the owners in proportion to their stock ownership.

Owners are protected from the liabilities of the business as in a C Corporation.

The S corporation structure is generally preferred over a standard corporation when most of the shareholders are employed by the corporation or are otherwise involved in its day-to-day activities. The corporation distributes most of its income to its shareholders each year.

The Non-Profit Corporation 

A non-profit corporation may be an industry association, a social organization, a research firm, or even a consulting group. It can sell products or services. The difference is that there are no owners, and any "profits" are simply retained by the corporation to be reinvested for whatever the purpose of the corporation may be.

A non-profit can have employees, and these employees can be paid fair market value for their services. There are many restrictions on non-profits that make it a challenging choice, but it's an option if you're interested in seeing your vision come to life.

These are special entity forms created for lawyers, doctors, CPAs, architects, engineers, and other professionals who are subject to licensing requirements and malpractice liability. They're similar to the standard forms, except that the appropriate state licensing body must usually approve the formation documents before they're filed with the Secretary of State.

Do I have to use an attorney to set up a business structure?

You aren't required to have an attorney prepare and file the paperwork necessary to create a business structure in the U.S. But you may want to consult with an attorney, depending on the size and complexity of your business. You should almost certainly consult with your tax advisor regarding which structure is best for your situation. 

What is the most common type of business structure?

The sole proprietorship is the most common election by most business owners. It's also the simplest and least expensive to enter into, typically requiring no steps toward formal organization. It can be ideal for many individuals such as independent contractors who simply want to work for themselves.

IRS. " LLC Filing As a Corporation or Partnership ."

Texas Secretary of State John B. Scott. " Selecting a Business Structure ."

How to write the structure and ownership section of your business plan?

Business planning is vital to the success of any entrepreneur because it helps them secure funding and find competent business partners. The document itself contains a variety of key sections, including the presentation of the legal structure and ownership of the business.

This section details the legal structure of your business and helps interested parties such as lenders and investors understand who they will be doing business with if they decide to go ahead and finance your company.

In this guide, we’ll look at the objective of the structure and ownership section, deepdive into the information you should include, and cover the ideal length. We’ll also assess the tools that can help you write your business plan.

Ready? Let’s get started!

In this guide:

What is the objective of the structure and ownership section of your business plan?

What information should i include when presenting the legal structure and ownership of my company in my business plan.

• How long should the structure and ownership section of your business plan be?
• Example of structure and ownership in a business plan

What tools should I use to write my business plan?

The objective of this section is to provide potential investors, lenders, and strategic partners with a clear and transparent view of your business's legal form, ownership distribution, and registration details. 

It aims to build credibility and trust by showcasing your commitment to openness and compliance with regulations. Let's take a look at some of the key objectives:

Communicate the legal form and registration details

• You should explicitly state your business's legal form. For example, your business might be corporation, sole proprietorship, or limited liability company (LLC). 
• Clearly explaining your chosen legal form helps stakeholders understand your entity's liability, taxation, and management implications.
• It is also essential to disclose where your company is registered. This information is vital as it provides clarity on the jurisdiction under which your business operates. 
• It also helps investors and lenders assess any legal and regulatory implications specific to the location of registration.

Identify shareholders

• Potential investors and lenders need to know who owns the company and the percentage of ownership each party holds. 
• By providing this information, you instill confidence in your business and help identify what needs to be verified as part of Know Your Customer (KYC) and Anti-Money Laundering (ALM) checks down the line.

Transparency is the cornerstone of credibility for businesses. By openly presenting the legal structure and ownership, you signal to potential investors that your business operates with integrity and adherence to regulations. 

Notably, anti-money laundering regulations require investors to verify the identity of all shareholders before committing funds. By providing a clear picture of the parties involved, you can facilitate this process and build trust with investors.

Venture capitalists (VC) firms and angel investors in particular, may have specific criteria such as location and ownership mandates governing the companies they can finance. Being transparent about your company's structure and ownership enables potential investors to assess whether your business aligns with their investment preferences and requirements.

Need a convincing business plan?

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The structure and ownership subsection arrives quite early in your business plan as it is the first part of the company section which is the second section of the document (after the executive summary) if you are following a standard business plan outline .

At this stage, the reader is still in the process of getting familiar with your business, and this section serves as a crucial foundation for potential investors and partners and helps them understand the core aspects of your business’s structure.

Here's what you should include:

Company registration details and registered office address

Provide information about when and where your company was registered and its registration number. This enables readers to understand the jurisdiction under which your business is operating and helps verify its legal existence.

Also, mention the registration date to showcase the company's longevity or recent establishment.

Include the registered office address of your company. This is the official address where the company can be contacted, and legal notices can be served. Providing this address demonstrates your commitment to compliance and transparency.

The information above needs to repeated for each subsidiary or joint venture owned by your business in order to provide a clear map of the coporate structure.

Overview of ownership

Offer a concise overview of the ownership structure of the company. Identify the shareholders, and specify their ownership percentages or shares. 

If there are numerous shareholders, list individuals or entities owning 5% or more, and highlight those with a controlling interest in the company or on the board.

If the business is controlled by another business, such as a holding company for example, it is also useful to explain who controls that business as well.

Roles and responsibilities of shareholders

In case of multiple shareholders, explain their respective roles and responsibilities within the organization. 

Differentiate between passive investors, board members, and executive or non-executive directors. 

Shareholders' agreement (if applicable)

If the business plan is presented for investment purposes, it is useful to clarify if a shareholders' agreement is in place between the existing investors. 

This agreement outlines the rights and obligations of shareholders and adds an extra layer of legal protection for investors and shareholders.

Expertise of co-shareholders

Highlight any shareholders who contribute more than just financial capital to the company. 

If, for instance, a shareholder is an industry expert and brings valuable advice, contacts, and credibility, emphasize this aspect. 

Doing so demonstrates the added value these shareholders bring to the business.

Group or franchise structure

If your company operates as part of a group or franchise, provide this information for each individual company receiving funds. 

Clarify the relationship between the main company and the individual entities within the group and their respective legal structures.

Addressing geographical restrictions

If some investors have geographical restrictions on their investments, clearly indicate whether your company meets their eligibility criteria. 

This helps investors quickly assess whether your business aligns with their investment mandates or not.

How long should the structure and ownership section of your business plan be? 

The length of your business plan's structure and ownership section requires a delicate balance. 

While a general rule of thumb suggests that it should be about 2 to 3 paragraphs, the actual length depends on several factors, including the complexity of your corporate structure and the number of shareholders involved.

The complexity of your corporate structure 

• A concise presentation may be sufficient if your company's legal structure is relatively straightforward, with a single owner or a small number of co-founders. 
• In such cases, aim to provide the necessary information without overwhelming the reader with unnecessary details. A paragraph or two may convey the key points effectively, ensuring clarity and brevity. 
• However, if you have a complex business structure, aim to provide details about members who play a key role in business continuity and profitability. 

The number of shareholders involved

• If your business involves multiple shareholders, each with significant ownership percentages or unique roles, you may need to dedicate more space to this section. 
• Do this by providing a comprehensive breakdown of ownership distribution and outlining each shareholder's contributions. 
• This may take up more space as you need to add additional information. However, if you have a pretty straightforward ownership structure, a paragraph or two will be sufficient enough.

Regardless of the complexity, striking the right balance between providing sufficient detail and avoiding excessive technical jargon is crucial. The structure and ownership section should be reader-friendly, allowing potential investors and stakeholders to understand the core aspects of your company without feeling overwhelmed by intricate legalities.

Repetition can dilute the impact of your message and unnecessarily lengthen the section. Ensure that you don't reiterate information that has already been covered in other parts of the business plan. Instead, focus on providing unique insights and details that enhance the reader's understanding of your corporate structure and ownership.

When crafting this section, prioritize the most critical points that investors or partners need to know about your company's structure and ownership. 

Focus on aspects that directly impact decision-making, such as the majority shareholder's influence, board composition, different classes of shares in issue, or any unique arrangements that set your business apart.

Need inspiration for your business plan?

The Business Plan Shop has dozens of business plan templates that you can use to get a clear idea of what a complete business plan looks like.

Example of structure and ownership section in a business plan 

Below is an example of what the structure and ownership section of your business plan might look like. As you can see, it is part of the overall company section and precedes the location and management team subsections.

The structure and ownership section of a business plan provides a detailed overview of how your company is organized and who holds ownership stakes in the business.

This example was taken from one of  our business plan templates .

In this section, we will review three solutions for creating a business plan for your business: using Word and Excel, hiring a consultant to write the business plan, and utilizing an online business plan software.

Create your business plan using Word and Excel

This is the old-fashioned way of creating a business plan (1990s style) and using Word and Excel has both pros and cons.

On the one hand, using either of these two programs is cheap and they are widely available. 

However, creating an error-free financial forecast with Excel is only possible if you have expertise in accounting and financial modeling.

Because of that investors and lenders might not trust the accuracy of your forecast unless you have a degree in finance or accounting.

Also, writing a business plan using Word means starting from scratch and formatting the document yourself once written - a process that can be quite tedious - especially when the numbers change and you need to manually update all the tables and text.

Ultimately, it's up to the business owner to decide which program is right for them and whether they have the expertise or resources needed to make Excel work. 

Hire a consultant to write your business plan

Outsourcing your business plan to a consultant can be a viable option, but it also presents certain drawbacks. 

On the plus side, consultants are experienced in writing business plans and adept at creating financial forecasts without errors. Furthermore, hiring a consultant can save you time and allow you to focus on the day-to-day operations of your business.

However, hiring consultants is expensive: budget at least £1.5k ($2.0k) for a complete business plan, more if you need to make changes after the initial version (which happens frequently after the first meetings with lenders).

For these reasons, outsourcing the plan to a consultant or accountant should be considered carefully, weighing both the advantages and disadvantages of hiring outside help.

Ultimately, it may be the right decision for some businesses, while others may find it beneficial to write their own business plan using an online software.

Use an online business plan software for your business plan

Another alternative is to use online business plan software .

There are several advantages to using specialized software:

• You are guided through the writing process by detailed instructions and examples for each part of the plan
• You can be inspired by already written business plan templates
• You can easily make your financial forecast by letting the software take care of the financial calculations for you without errors
• You get a professional document, formatted and ready to be sent to your bank
• The software will enable you to easily track your actual financial performance against your forecast and update your forecast as time goes by

If you're interested in using this type of solution, you can try our software for free by signing up here .

To sum it up, a well-written structure and ownership subsection is key to ensuring that the reader is clear on who controls the business, and whether or not it fits their investment criterias.

Also on The Business Plan Shop

• How to do a market analysis for a business plan
• How to present your management team in your business plan?
• Where to write the conclusion of your business plan?
• Executive Summary - The most crucial part of your business plan
• How to write the location section of your business plan?
• How to present the management team in your business plan?

Know someone who needs help writing-up their business plan? Share this article with them and help them out!

Founder & CEO at The Business Plan Shop Ltd

Guillaume Le Brouster is a seasoned entrepreneur and financier.

Guillaume has been an entrepreneur for more than a decade and has first-hand experience of starting, running, and growing a successful business.

Prior to being a business owner, Guillaume worked in investment banking and private equity, where he spent most of his time creating complex financial forecasts, writing business plans, and analysing financial statements to make financing and investment decisions.

Guillaume holds a Master's Degree in Finance from ESCP Business School and a Bachelor of Science in Business & Management from Paris Dauphine University.

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Legal Form of Organization in Business Plan

The legal form of organization in business plan is used to decide how the company will function, how roles will be assigned and how relationships will work. 3 min read updated on February 01, 2023

The legal form of organization in business plan is used to decide how the organization will function, how roles will be arranged and assigned, and how relationships will work. These organizational steps should take place at the beginning of the business formation.

Starting a Business

The first step when beginning a business is to name the business. The name must be unique and not in use by another existing entity. The next step is to decide on the organization type your business will use. Each business entity has specific requirements on how they are run including how income is reported. The business types include:

• Sole proprietorship.
• Partnership.
• Limited Liability Company.
• Limited Liability Partnership.
• Corporation.
• S Corporation.
• Tax-exempt organization.

Each type has advantages and disadvantages that should be reviewed before making a final decision. However, the business type you choose isn't permanent. As the needs of your business change, the business entity type can be changed. Examples include:

• Changing a sole proprietorship to a partnership due to growth.
• Switching to a corporation to establish protection that comes with limited liability.

Limited Liability is attractive to business owners because it protects personal assets from any debts or obligations incurred by the corporation.

Business Type Requirements

A major component of selecting a business type is what is required to be legal and the tax implications.

• Applications to the state government are not required.
• Dependent on the state, registering the business may be required with the state and/or country.
• A business license may be required based on the type of business and state requirements.
• The IRS views all business activity as personal. When filing, personal and business income are seen as the same thing.
• A sole proprietorship is personally responsible for all aspects of the business. If the business is sold, it can impact any personal assets if you are found liable.
• In a general partnership, two or more sole proprietors are seen by the IRS as having equal responsibility.
• Any profit and loss distribution is determined by the partnership agreement and is then passed to the individual partners.
• Profit and loss distribution does not have to match the percentage of ownership.
• The partnership is not subject to income or franchise tax.
• The structure and tax implications are similar to a general partnership, but a limited partnership ( silent partner ) allows for ownership without the requirement of being actively involved in how the business is managed.
• Business liabilities are limited to the amount invested by the partner.
• Outside investors can be partners without taking on any liabilities.
• Personal liability protection is provided without having to meet the administrative and governance procedures.
• The Articles of Organization determine the ownership percentages, distribution of profit and losses, and voting rights. In corporations, this is determined by stock ownership.
• Most LLCs use the pass-through method of taxation. This means that taxes aren't paid by the LLC, but by at the personal tax level of the owners. The personal rate is lower than the corporate tax rate. When the LLC files taxes, no money is sent and an owners report is included to show the owners will pay the tax instead.
• Based on the state, the LLC is subject to a franchise tax .
• A corporation can be formed as for-profit or nonprofit.
• Corporations provide a shield from liabilities. This protection is only removed if the owners or board members have been found to be illegally running a corporation and have been breaking federal and/or state laws.
• Corporations can sell stock in the business.
• A Board of Directors is used to manage corporate policies and strategies. This is for both for-profit and nonprofit.
• Corporations continue to exist even in the event of the owner's death, or if owners leave.

If you need help with the legal form of organization in the business plan, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.

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• Types of Business Structures
• Best Type of Corporation for Small Business
• Partnership Business Entity: Everything You Need To Know
• Types of Companies LLC
• LLC Partnership
• Individual Ownership of Business
• Partnership Advantages and Disadvantages
• What Is Classification of Business According to Ownership?
• Types of Business Entities
• Benefits of a Close Corporation as Opposed to a Partnership

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• Legal Structure of a Business
• LawDistrict ❯
• Legal Dictionary
• What Is a Legal Structure?

A legal structure is an organizational framework for how a business entity operates . Also called a business structure, a business form, or a business ownership structure, the proper legal structure depends on the size and type of your business and your business goals.

Typical business legal structures include sole proprietorships , limited liability companies ( LLCs ), partnerships (such as LLPs ), and corporations .

• How Do I Choose the Right Legal Structure?

Different legal structures come with distinct advantages and disadvantages. In most cases, the criteria you will evaluate to select the right format involve the following:

• owner liability
• expenses and procedures needed to create and run the business structure
• how the business will be taxed
• investment needs

Owner liability : The more risk involved with the service or product your business provides, the more important owner liability becomes.

Both corporations and LLCs offer business owners some personal liability protection against someone making claims against the business. In fact, this protection is one of the main benefits of an LLC. Conversely, owners of partnerships and sole proprietorships have little personal protection.

Expenses and procedures : Sole proprietorships and partnerships do not require much in the way of fees and documents to start a business . Partnerships do need to create a partnership agreement that specifies who does what in the company.

However, you must file articles of incorporation with your secretary of state's office and pay associated fees to establish a corporation or an LLC. Required fees and forms, such as an LLC operating agreement , vary from state to state.

In addition, the owners of businesses with these two business structures must elect officers to elect to run the company and maintain detailed records of any critical business decisions.

Taxes: The business structure you choose also affects your income tax status . Sole proprietorships, partnerships, and LLCs are "pass-through" tax entities, meaning the taxes on business profits and losses "pass through" to the owners on their personal income taxes. However, these owners must file taxes on all net profits from their business, even if they take no money out of the company during the tax year.

Unlike the "pass-through" structures, corporations are considered separate tax entities. These business owners pay taxes only on the profits they actually take from the business in the form of salaries, dividends, or bonuses. Also, the corporation pays taxes at a lower tax rate than some individuals do.

Investment needs: If your business relies on investors, then a corporation may be the right business structure. Structuring as a corporation allows a company to sell shares of ownership through stock offerings. The previous business structures cannot offer stock.

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FAQs About Business Structures

What about llc vs. sole proprietorship.

Deciding between an LLC and a sole proprietorship is a difficult choice when it comes to legal structure . Many entrepreneurs launch their businesses as sole proprietorships because they are easy and inexpensive to set up and maintain. All profits and losses "pass through" to the owner's personal tax return, and the owner does not need to pay business taxes.

However, a sole proprietorship is not considered a separate legal entity. Therefore, the owner has unlimited liability protection and can be held personally liable for the obligations of the business.

As their businesses grow, many sole proprietors restructure their businesses as LLCs , which offer the pass-through tax advantage and limited liability protection.

Is a business plan essential?

A well-thought-out business plan serves as a guide for launching and managing your business and choosing its legal structure . When you go through the steps of how to write a business plan , you'll be able to see more clearly what legal structure you'll need for your endeavor.

Traditional business plans use a standard structure and offer details on each aspect of the business. A lean startup business plan uses the same structure but summarizes the key elements.

Depending on your type of business and the structure you choose, you may need to apply for a business registration number . You will use this number to file taxes, open up a bank account, and conduct other official business.

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Choosing the Right Legal Structure

What does your business want to be when it grows up? Once you've written a solid business plan that answers this question, you're ready to begin thinking about a legal structure for your new venture. "You need to know where your business is headed," says CPA Craig Malmgren, a tax manager at the firm of Lautze and Lautze in Oakland.

For instance: Do you plan to work alone? Do you plan to add employees over the next few years? Do you hope, some day, to be a corporation? And what will that corporation look like? Will it be small? Or large? Or somewhere in between?

But there's more. You'll also need to factor in tax, legal and compliance considerations. And to thoroughly examine these considerations, you'll need to seek professional help.

"Choosing a legal structure can be a complicated decision," says Malmgren. "And with the introduction of limited liability companies and limited liability partnerships, as well as major revisions in the S Corporation operating rules, the decision has become even more complex."

When attempting to sort through the various legal entities that your business can form under, the first step is to consult with your CPA, who can help you discuss options and plans for the future of your business. Depending on the complexity of the legal structures you're considering, your CPA will then refer you to an attorney. And if you're considering anything other than a sole proprietorship, Malmgren suggests that you spend the legal fees now in order to save time and money later. "An attorney can help you decide what the best entity would be for your scenario," he says. "And then they can help you with the legalities of setting it up."

A good attorney will weigh all the necessary factors to help you choose the best structure for your business. The type of business you're starting and the liabilities you'll assume, the distribution of the business' earnings, and your capital needs will all be important factors in choosing a structure. In addition, an attorney will weigh the legal restrictions and the tax advantages and disadvantages for your particular situation.

Know Your Structures

Most likely, your business' structure will fall into one of the following categories:

• Sole Proprietorship: This is the easiest and least expensive structure. There will be some costs to obtain a business name registration and other licenses, but attorney's fees will be minimal because there are fewer documents to prepare than in a partnership, corporation or LLC. In a sole proprietorship, the owner has complete authority over all business decisions.
• Partnership: Partnerships come in different forms. General partnerships result in no entity income tax and allow all partners to be involved in management decisions. Limited partnerships are more suitable for investors who want limited liability and are willing to give up the right to participate in management. But whatever type of partnership you form, it's important to remember this: Back it up with a legal agreement drawn by an attorney. The legal fees for forming a partnership will be higher than the fees you'll pay to establish a sole proprietorship, but they are usually less than the fees associated with incorporation. In a partnership, each partner is responsible for the other partner's actions as well as their own.
• Corporation: This structure is more complex than the sole proprietorship and the partnership, and is usually more expensive to set up. Corporations can be incorporated in a number of ways, including the formation of C or S corporations. If your corporation meets eligibility requirements, it can avoid double taxation to the shareholders and to the corporation by electing to be treated as an S corporation. S corporations are generally exempt from federal tax. C Corporations are taxable entities. In a corporation, control of business decisions depends on stock ownership, and decisions are generally made by a board of directors.
• LLC and LLP: Limited Liability Companies and Limited Liability Partnerships are not as expensive to set up as corporations, but they provide the benefit of limited liability. They are also easier to dissolve than corporations. For income tax purposes, LLCs and LLPs can be taxed either as corporations or partnerships. But unlike partnerships, they are subject to a progressive fee structure based on gross receipts. In LLCs and LLPs, the manager may have control of business decisions but all members are allowed to participate actively in the operation of the business.

Seek Professional Help

Instead, they should make educated, informed decisions that will help them to invest in their business' future. And with the guidance of a good team of tax and legal experts, you'll be certain to make the right decision about your business' legal structure -- a decision that'll save you money and headaches in the years to come.

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How to Determine the Legal Structure of Your Business

Digital library > building and inspiring an organization > forms of business, “how to determine the legal structure of your business”.

Should your business be a proprietorship, partnership, limited partnership, C corporation, S corporation, or LLC? Be informed to help determine the best business structure for you.

This Business Builder will provide you with the information you need to help determine the best business structure for you.

WHAT YOU SHOULD KNOW BEFORE GETTING STARTED [ top ]

Going into business requires not only the knowledge of your trade but the understanding of the laws on a local, state, and federal level. There are many reasons today for owner-managers of small businesses to look at the legal business structure of their firms. Changing laws and the need for capital are just two of the many factors which require owner-managers to carefully evaluate which legal structures best meet their needs. This Business Builder will provide you with the information you need to help determine the best business structure for you.

As a small business owner, you must play many roles in order to keep the business functioning smoothly and properly. However, there are times that you shouldn’t try to be lawyer, accountant, marketing specialist, foreman, salesman, etc. Instead, take advantage of the professional advice that is so readily available. A good attorney or CPA can help you interpret the many legal and technical issues which pertain to any one or all of the legal structures for business. Your savings in time and money for utilizing a professional advisor can far outweigh the possible expense of missteps and wrong turns when selecting the business structure for your firm. Because laws are constantly changing, it is best to consult an attorney or accountant for the latest in regulations and requirements before you decide on the right business structure for you.

WHAT ARE MY ALTERNATIVES? [ top ]

In order to intelligently select the legal structure of your business, you must be knowledgeable about the alternatives from which you may choose. A business venture can be structured in several ways; however, the law classifies businesses so that most fall into one of three legal forms. They are:

There are also variations on some of these basic legal forms — the S corporation, the limited partnership, and the limited liability company (LLC), a relatively new form of business organization, which has gained legal status in a majority of states.

Each business structure you are about to review has its advantages and disadvantages. There is no good or bad structure. The optimum choice depends solely on your personal situation. Read through each section carefully. Then, decide which structure is best suited to your business needs.

Sole Proprietorship

The simplest (and least amount of paperwork) of any of the legal business structures is the sole proprietorship. To establish a sole proprietorship, you will need a good idea, a lot of determination, and an endless supply of energy for the hard work ahead. However, the only paperwork you’ll need is that required for filing a fictitious name (if you decide not to use your own) and whatever licenses you’ll need to begin your operations. You are not required to perform any formal action to set up a sole proprietorship. Consequently, there is no need to hire professionals to file required government documents to get you started. You do it all yourself!

With nearly three quarters of all businesses operating as sole proprietorships, this business structure is by far the most popular of any of the structures. In fact, many businesses that are partnerships and corporations today, initially started out as sole proprietorships and changed when it became advantageous to do so.

As a sole proprietorship, the business is owned and operated by one person — you! You don’t have any partners to confer with or boards to answer to. The law recognizes you and the business as one in the same. The business is you; you are the business. And it’s this single entity status that is responsible for the advantages of setting up as a sole proprietor and the disadvantages, as well.

For example, Gina has decided to start up her own advertising firm on a part-time basis. Her plan is to continue her job as Director of Advertising for her town’s leading newspaper until she is making enough money on her own to go it alone full-time. In the first years of operating her part-time business, Gina is able to off-set her income from the newspaper with the net losses from her part-time business to reduce the overall income tax she must pay as an individual.

Disadvantages

For instance, let’s say your widget business has suffered a significant loss in market share due to increased competition from the Pacific Rim. You’ve done everything in your power to hold on, but you’re left with no other alternative but to liquidate. Unfortunately, after your "going out of business sale" you still have some outstanding debts, and these creditors are unwilling to work out any kind of extended payment plan whatsoever to satisfy the debt. Therefore, you are forced to sell your house and auction your belongings to cover the debt. Both you and your business are ruined.

General Partnership

According to the Uniform Partnership Act (which most states have adopted), a partnership is an "association of two or more persons to carry on as co-owners of a business for profit." Frequently, you may decide to take on a partner because he has skills or expertise that you may lack. However, take special care in choosing a suitable partner. Don’t select the first person that offers to make an investment in your company. A partnership is a marriage in many ways; however, few take the time and put in the effort to pick a partner that they would in choosing a spouse. Nevertheless, many a business has had to close its doors because the business union did not work.

In many ways the partnership structure is very similar to the sole proprietorship. For instance, there is unlimited liability for partners and a limited life of the business. Where it differs, however, is that you can share the work, financial pressures, decision-making, and everything else that goes along with the business with a trusted colleague. If you’ve selected your partners well, you can expect to reap synergistic benefits.

There can be many different variations on the partnership theme, depending upon how active your partners are. You can have general partners who share in the managing, financing and liability of the company, or you can have limited partners, who do not take an active role in the managing of the business but whose liability is limited to their investment. More on limited partnerships will be discussed later in the Business Builder. Also, partnerships don’t necessarily have to be divided up equally, either. It is perfectly legitimate for one partner to have majority ownership.

For example, Larry’s Limited, a wholesaler of farm equipment, was structured as a general partnership with Larry, Harry, and Barry as co-owners. Because of the various levels of experience and capital that each owner brought to the business, it was decided that each partner’s share of the business would directly relate to his contribution. Since Larry had formerly run a similar company and was providing the majority of seed capital for startup, it was decided that he would retain 50% share of the business while Harry and Barry each would have 25%.

Now, let’s look at some of the major advantages and disadvantages of a partnership.

Partnership Agreement

Although not legally required, a Partnership Agreement, also known as Articles of Partnership, are often drawn up to outline the contribution of each of the partners into the business. These articles determine the roles of the partners in the business relationship, whether financial, material, or managerial. Following are some you might want to include in your "written articles of partnership" to protect the best interest of your partnership.

Limited Partnerships

In a limited partnership, the law provides for a special kind of arrangement whereby certain partners have limited personal liability. The limited partnership is more regulated than the more common general partnership, but it allows investors who will not be actively involved in the partnership’s operations to become partners without being exposed to unlimited liabilities of the business’ debts if it should go out of business.

A limited partner risks only his or her investment but in exchange for this must allow one or more general partners to exercise control over the business. In fact, if the limited partner becomes involved in the operations of the partnership, he or she may lose his or her protected status as a limited partner. The general partners in a limited partnership are fully liable for the debts of the partnership.

There are state laws requiring certain formalities in a limited partnership that are not required in other partnerships. To qualify for their special status, limited partnerships must usually file a Certificate of Limited Partnership with the secretary of state or other state and county offices. Establishing a limited partnership also requires a written partnership agreement.

Corporation

This type of business structure is considered the most formalized and complex form of business organization. It is costlier, more difficult and requires more paperwork.

A corporation is a separate legal entity which is organized in accordance with state and federal statutes. Ownership is divided into shares of stock. The business activities are dictated by a charter stating the powers and limitations of the particular business. Corporations which do business in more than one state must comply with the Federal laws regarding interstate commerce and with the state laws, which may vary considerably.

Now, let’s look at some of the advantages and disadvantages of a corporation.

An S corporation is like any other corporation in terms of corporate law requirements, limited liability of shareholders, and all other corporate aspects, except tax treatment. An S corporation is a regular corporation which has essentially elected to be treated somewhat like a partnership for federal income tax purposes. S corporations do not pay tax at the corporate level. Instead, taxable income, losses, deductions, and credits are passed through to the corporation’s stockholders. Tax law changes enacted by the Tax Reform Act of 1986 have caused many businesses currently taxed under corporate tax rules (known as "C" corporations) to reexamine their tax options.

When operating as an S corporation, individuals are taxed at a top tax rate of 28%. Corporations, on the other hand, are taxed at a maximum rate of 34%. (These figures are subject to change. Consult your tax advisor for the current rates.) Obviously, paying taxes as an S corporation may be more desirable under the new law.

In certain instances, an S corporation may be subject to tax on "built-in gains." Built-in gains are untaxed gains on the assets of a corporation that would have been recognized as taxable if the assets had been sold at fair market value on the day a corporation became an S corporation.

Profits of the corporation are scheduled to be disbursed to the shareholders on the last day of the corporation’s tax year, whether or not the profits are actually distributed. Consequently, if an S corporation’s profits are distributed as dividends, the distribution itself is usually not taxable, so there is not double taxation of distributed profits.

In addition to the income tax advantages, an S corporation status can eliminate accumulated earnings tax problems because all earnings, whether distributed or not, are taxed to the stockholders each year. In addition, S corporation stockholders can apply their deductible personal losses against their pro rata share of the company’s taxable income. They can also deduct their pro rata share of an S corporation’s net operating loss from their personal gross income.

In order to qualify as an S corporation, your business must meet the following requirements:

The corporation must be created under the laws of the U.S. or one of the 50 states.

The corporation must have 35 or fewer stockholders. (A husband and wife will be considered a single stockholder.)

All stockholders must be individuals, decedents’ estates, bankruptcy estates, or certain types of trusts.

An S corporation election should not be made without the advice and assistance of a tax professional, since it is a very complex and technical area of the tax law.

Electing S corporation status for a corporation is usually most favorable in these situations:

Where it is expected that the corporation will experience losses for the initial year or years of doing business and where the shareholders will have income from other sources the business losses can shelter from tax.

Where, because of the low tax brackets of the shareholders, there will be tax savings if the anticipated profits of the business are passed through to them rather than being taxed at corporate tax rates.

Where the nature of the business is such that the corporation does not need to retain a major portion of profits in the business. In this case, all or most of the profits can be distributed as dividends without the double taxation that would occur if no S corporation status were in effect.

Where a business is in danger of incurring an accumulated earnings penalty tax for failure to pay out its profits as dividends.

Possible disadvantages of S corporation status must also be considered. The taxable income of an S corporation is taxed to stockholders even if the income is not actually distributed to them. Consequently, if the cash flow of a business is uneven or uncertain, S corporation status may not be the wisest choice. Finally, certain items that are tax deductible for a C corporation, such as the costs of certain fringe benefits, are not deductible for an S corporation.

Limited Liability Companies

In addition to the three major forms of business structures discussed, many states have adopted a new type of entity called a limited liability company (LLC). An LLC is similar to and taxed as a partnership, and it offers the benefit of limited liability like corporations and S corporations.

In 1988, a Wyoming limited liability company was permitted to be classified as a partnership for federal income tax purposes, despite its limited liability, due to the short-term life of the business. In some states, LLCs are required to terminate in a specified period of years, usually 30 years or less. LLCs offer the corporate benefits of limited liability, while retaining the flexible flow-through tax treatment of a partnership.

As in all other business structures, there are disadvantages to the LLC. Because not all states have adopted a limited liability company law, if you set up an LLC in one state which allows LLCs and you do business in another state, which does not, your LLC may not provide any limited liability protection from creditors in that state. This is a severe risk, and one you won’t face if your business is incorporated.

As your business matures, the initial choice of a business structure, no matter how well it performed in the startup phase, may require adjustment or alteration.

Ask yourself the following questions as an aid in determining what business structure may best suit your business plan.

RESOURCES [ top ]

U.S. Small Business Administration

Delaware Small Business Development Center

Writer: Lynn Phillips

All rights reserved. The text of this publication, or any part thereof, may not be reproduced in any manner whatsoever without written permission from the publisher.

Legal Structure of a Business

The different business structures impact taxes, financing, and personal liability. See which legal structure suits your needs.

One of the first decisions a new business owner makes is what type of legal structure the business will have. There are several different ways to set up your company, and each will have implications as far as taxes, financing, and your personal liability.

Let’s take a look at the options, and the benefits and drawbacks of each. Of course, your individual circumstances will dictate which structure makes the most sense for you, so be sure to get professional legal advice before making a decision.

Sole Proprietorship

A sole proprietorship is a business owned by a single individual. This is the easiest type of structure to set up. That doesn’t mean there are no regulations to follow, however. The procedure will vary from state to state, but the steps to acting as a sole proprietorship are very simple.

BUSINESS NAME CHOICE

Business name registration, licenses and permits, employee identification number (ein).

It’s important for tax purposes to keep your business and personal finances separate, so set up a business bank account and get a business credit card. A sole proprietorship doesn’t offer you any personal protection from legal claims against the business, so it’s a good idea to get liability insurance, as well. You will also be personally responsible for the business’s financial obligations, so consider a business liability insurance policy too.

Depending on what type of business you’re in, you may have to report sales or other taxes. Income taxes will be filed as personal income on your individual return with a Schedule C attached. You pay all the taxes an employer would otherwise pay for you, such as contributions to Social Security and Medicare, and you may have to pay estimated taxes throughout the year. Speak with an accountant and make sure you understand and follow through on the requirements.

Partnership

A partnership is when two or more people combine to share in the profits or losses of a business. Similar to a sole proprietorship, money made or lost is reported personally by the partners on their individual income tax returns. Generally, the steps to forming a partnership are similar to those for sole proprietorships, and again, may vary slightly from state to state.

There are a few different types of partnerships, but the two most common are general and limited.

General Partnerships

In a general partnership legal structure, ownership and management responsibility are usually shared equally between the people involved. If a different distribution is being used, you would spell that out in your partnership agreement.

Limited Partnerships

Limited partnerships are usually formed when one person is doing most of the actual work and another (or others) have invested money. The general partner will typically run the business, and the other partners will have limits on their involvement. Again, these would be outlined in your agreement. You are not legally required to have a written partnership agreement , but it is smart business practice to do so.

Managing A Partnership Legal Structure

Another thing to keep in mind about partnerships is that if a partner wants to leave, the other(s) will have to buy him or her out, or dissolve the business. This is another reason it’s smart to have a written agreement, one that includes a buy-sell or buyout agreement.

In a partnership, the partners are still personally liable for all obligations of the business. That means if the business defaults, a creditor can come after your house, car or anything else you own. (Limited partners may have limited liability.)

Another aspect of a partnership is that any of the individual partners can legally commit the business to a contract, even one that the other partners may not agree with or even be aware of. Between being responsible for the business’s debt and the ability of each partner to bind the partnership to contracts, it’s vitally important to trust anyone you’re considering entering into a partnership with, and to also be sure that your personalities will complement each other and you’ll be able to work together.

As with sole proprietorships, the income or loss of a partnership passes through to the owners, and is accounted for on their individual tax returns.

Corporation

A corporation, or C corporation, is an independent entity for both legal and tax purposes, separate from the people who own it or run it. A corporation can raise money by selling stock, and a corporation will continue indefinitely, even if one of the shareholders dies or sells his or her shares. Owners of a corporation are not personally responsible for the financial obligations of the corporation, nor are they personally liable in case of lawsuits.

The corporation legal structure can be complicated to set up and manage, but it’s an independent entity that may benefit business owners in the long run.

Because of this separate status, the corporation itself pays taxes; the income is not passed through to the owners’ individual tax returns. Owners would pay taxes just as any other employee of a business would: on the money they get for salaries, bonuses and other benefits. One thing to be aware of is the potential for double taxation. As an owner, you would pay taxes on whatever salary you draw from the company, but you would also pay corporate taxes on the profits of the business.

It’s a far more complicated, expensive, and lengthier process to set up a corporation. The rules for forming corporations are set by each state, and each has a list of regulations, as well. You need to prepare articles of incorporation and a set of bylaws describing how the corporation will be run. You’ll most likely need an attorney to help you with the paperwork and certifications involved.

Once you’re up and running, you’ll probably need an accountant to handle the more complicated tax calculations and filings. You’ll need to register with the IRS and state and local tax agencies, get an EIN, and pay taxes on your corporate profit. You’ll also need to pay a portion of your employees’ Social Security and Medicare taxes.

S Corporation

If your business qualifies according to the IRS rules , you might choose to become a special class of corporation known as an S corp. To be classified as an S corporation, you still have to become a corporation, following the general procedure outlined above.

Like a C corporation, an S corp is also a separate entity from its owners, so your financial liability would still be limited, but its profits or losses would pass through to your individual tax return. The business itself is not taxed, so you’re not open to the potential of being taxed twice.

S corporations can only issue common stock, which experts say can make it harder to raise capital. S corps can also only be owned by individuals, estates, and some kinds of trusts, so you limit the type of investors you can attract.

Limited Liability Company (LLC)

In many ways, this type of structure offers the benefits of both a corporation and a partnership. The owners are protected from having personal liability, as they would in a corporation, but an LLC follows the more streamlined structure of a partnership. To set up an LLC, you have to file with your state, and some states will also require an operating agreement, which is similar to a partnership agreement. LLCs cannot sell stock, although you can give a percentage of ownership to outside investors.

The LLC legal structure offers the benefits of both a corporation and a partnership for many business owners.

In an LLC, the owners are known as “members.” Members can be people, partnerships, corporations, or even other LLCs. The profits and losses are passed through LLCs to their members, who report them on their individual returns, just as in a partnership.

As with partnerships and sole proprietorships, LLC members are considered self-employed, and have to make their own tax contributions toward Medicare and Social Security. An LLC can also request S corporation status, which may offer other tax benefits. An attorney or accountant could advise you about that.

Why might you opt for an LLC instead of an S corporation? Filing as an LLC means less paperwork and fewer costs to get started. There are also fewer restrictions on how the profits in an LLC are shared among its members. On the downside, similar to partnerships, if a member leaves, in many states the business is dissolved, although you can put provisions about that in your operating agreement.

Legal Structures Are Not Set in Stone

One very important thing to keep in mind is that you can change the organizational structure of your business if your situation changes. It’s possible to start off as a sole proprietorship and convert to an LLC or corporation. As your needs grow and change, the structure of your business can change with them. As always, it’s best to consult with your attorney and accountant about what would be most suitable for you.

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Legal Structure of a Business

Last updated on 21st April 2023

In this article

According to Government statistics there are 5.9 million private sector businesses in the UK; of these:

• 5.82 million businesses are small businesses (0 to 49 employees).
• 35,600 businesses are medium-sized (50 to 249 employees).
• 7,700 businesses are large (250 or more employees).

Small and medium-sized enterprises (SMEs) account for three fifths of the employment and around half of turnover in the UK private sector. 76% of private sector businesses did not employ anyone aside from the business owner(s).

These ‘no employees’ businesses comprise sole proprietorships and partnerships with only a self-employed owner-manager(s), and companies with one employee, assumed to be an employee-director.

Figures from the Department for Business, Energy and Industrial Strategy state that 16% of all SMEs operate in the construction industry; professional, scientific and technical activities account for 15% of all SMEs; whilst 10% are in the wholesale, retail trade and repair sector.

Private sector businesses are not evenly distributed across the UK. Based on head office location, rather than location of specific branches/sites, London and South East England have considerably more businesses than any other UK country or region of England.

What is the legal structure of a business?

Identifying the right legal UK business structure is a crucial part of a business start-up. When you start a business, the structure you choose will have significant implications on the amount of tax you pay, the degree of your personal liability should the business fail, the amount of administrative work involved and even your ability to raise finance.

As your business structure clearly defines your legal responsibilities, it is essential to put the time into researching which structure is the best fit for you.

The legal business structure is something you need to decide at the outset, although you can change it later on if required. All business structures have advantages and disadvantages, depending on factors such as the size of your business, the nature of your business and your future plans for the business.

What are the main types of legal business structures?

There are three main legal forms of businesses in the private sector:

• Sole proprietorships or sole traders.
• Partnerships.

Sole proprietorships are the most common legal form of a business. At the start of 2019 the UK private sector business population comprised 3.5 million sole proprietorships (59% of the total), 2.0 million actively trading companies (34%) and 405,000 ordinary partnerships (7%).

The Office for National Statistics ( ONS ) figures state that just over three quarters of UK private sector businesses are non-employers, and the majority of these are not registered for either Value Added Tax (VAT) or Pay as you Earn (PAYE) taxes.

Partnerships are probably the simplest way that two or more people can get together to run a business. This way of running a business is very old, and the law governing it dates back to the Partnership Act 1890 , which defines a partnership as “the relation which subsists between persons carrying on a business in common with a view to profit”.

This Act was followed by the lower profile but still used and relevant Limited Partnerships Act of 1907, but it was then almost a century before the next major piece of partnerships legislation arrived in the Limited Liability Partnerships Act of 2000.

HM Customs and Revenue ( HMRC ) records suggest partnerships account for around £150 billion of turnover a year and that around 7% of UK businesses are partnerships.

The majority of UK partnerships are small businesses, with 55% having business turnover under £75,000. However, there is a significant group of slightly larger business partnerships, 41%, that have turnover of between £75,000 and £1 million, and a very small number of major professional service firms operate as partnerships.

There are two types of company business structure that have limited liability:

• Private limited companies (Ltd).
• Public limited companies (PLC).

These businesses exist separately from their owners, who are known as shareholders. Employees are employed by the Ltd or PLC, and assets such as buildings or machinery, are owned by the Ltd or PLC.

This separate legal existence is known as incorporation. Any legal action is taken against the business and not the shareholders. Shareholders are only liable to lose the amount of money they have invested in the business therefore their liability is limited.

In addition to these main business structures there are a growing number of business organisations that are not in business for the money; instead their focus is on social or ethical objectives.

These include charities, co-operatives and social enterprises, which between them provide a wide range of goods and services and reinvest their profits into creating positive social change.

Why does the legal structure matter?

Getting your business structure right is important. One business structure is not necessarily better than another, but each has its own advantages and disadvantages.

Choosing the correct structure is an important decision as it will affect the way that your business is organised, your and your business’s legal obligations and tax position, filing requirements and your personal liability to third parties.

When thinking about which business structure will work for you, it may be helpful to consider the following:

• Who owns the business?
• Who do you want to manage the business?
• What is the tax position of each structure?
• How risk averse are you?
• Is personal liability a potential issue?
• What are the costs involved in setting up and running the structure?
• What formalities do you want to deal with?
• Is a structure with increased formalities worthwhile at this point in your business’s lifecycle?
• Are you happy for certain information to be made public?
• Are exit strategies important to you, for example, are you likely to want to sell your business in the future?

What is the legal business structure of a sole trader?

A simple and agile business structure, but it can incur a lot of personal risk. Sole traders are individuals who run a business on their own with no separate legal personality or limitation of liability and no legal formalities or administration or filing requirements.

There is no separation between the management and ownership of the business, the sole trader owns all the assets personally and has full control over the business. Sole traders often rely on their own savings and perhaps secured business loans to start their business.

Costs to set up as a sole trader can be fairly minimal depending upon the type of business you are establishing; however, this business structure exposes you to more personal risk than other business structures, so it may not be suitable for a high-cost start-up.

A sole trader is considered to be ‘ self-employed ’. This means you must register with HM Revenue and Customs ( HMRC ) for self-assessment as soon as you start trading as a sole trader . You will pay income tax, make National Insurance (NI) contributions through self-assessment and will be individually responsible for paying these.

A sole trader gets the benefit of the personal tax-free threshold; however, you will be taxed at basic and higher tax rates for the profit you generate. As your profit increases, it may cease to be beneficial to remain as a sole trader.

A sole trader runs the business as an individual in their own name, although many choose to use a trading name for the business.

However, even with a trading name the business is not a separate legal entity. Sole traders receive 100% of any profit but also bear 100% of any loss and are responsible for all debts and liabilities of the business.

This means that you are personally responsible for any debts incurred by the business. This is sometimes referred to as unlimited liability. As a sole trader, you have personal liability for any business debts and any contractual obligations. An example of this might be leasing premises for a business on a two-year lease, the business fails within the first year, however, the sole trader is liable for the ongoing costs for the length of the lease.

If the sole trader defaults then the creditors can ask the courts for payment or to seize and sell personal assets to pay the money owed. These assets can include personal property, cars, in fact anything of value.

There is minimal red tape for a sole trader, there is no need to register the business with Companies House , there are no incorporation or ongoing filing requirements and your business accounts can remain private. A sole trader, however, may wish to register for VAT and some trades may require other regulatory obligations to be fulfilled. You can set your own policies and working practices and employ staff within UK employment law.

Because you can make decisions alone, it can be quick and simple to make changes to the business to adapt to changing circumstances, for example, you can change your pricing structure or change the products or services that you offer, adding new products or services or removing those you don’t have faith in.

This ability to make swift decisions and implement them quickly can be a key advantage for a sole trader in a competitive, quickly changing market. As well as being the sole decision maker, a sole trader will generally be close to their customers and can therefore be sensitive to the needs of their clients, attuned to their requirements and able to react quickly and decisively to them. A sole trader can build up trust and confidence based on personal service.

However, there are some organisations that can’t or won’t do business with sole traders; many businesses will want the extra reassurance that comes with being incorporated as a limited liability company.

As a rule, banks and other investors are wary of dealing with sole traders, again because it is a risky business structure, so raising finance to expand may prove difficult.

Winding down and closing your business as a sole trader is a relatively simple affair. A sole trader business can be wound down by settling any liabilities, collecting monies due, keeping or selling any physical or proprietary assets, distributing any residual monies to the owner and finally notifying HMRC.

What is the legal business structure of a partnership?

Partnerships are often found in professions such as solicitors, architects, accountants and doctors, but can be found in any type of business activity. They are a streamlined set-up for business partners who know and trust each other well.

Partnerships fall into three categories:

• Ordinary or traditional partnerships.
• Limited partnerships.
• Limited liability partnerships (LLPs).

Before setting up any partnership there are a number of important things to work out before you start your business.

These include:

• The percentage ownership of each partner.
• Who contributes what into the partnership, and whether those assets belong to the partnership or not if the business is later sold or wound up.
• How profits and losses will be allocated.
• How decisions will be made at meetings, and possibly whether any partner has a casting vote or more say on a particular matter.
• The principal duties of each partner.
• The limits of authority of each partner who makes decisions by themselves, for example you might agree that no partner can borrow or make an order for more than £1000 without the agreement of the others.
• The procedure for admitting a new partner.
• The procedure for removing a partner from the partnership, or what happens when a partner decides to leave.

Ordinary or traditional partnerships

An ordinary or traditional partnership does not have any legal existence distinct from the individual partners. If a partner resigns, goes bankrupt or passes away, the partnership will need to be dissolved; however, the business can continue.

Using this type of partnership is a reasonably easy and fast method for two parties or a group of people to set up, own and manage a business. There is no upper limit on the number of partners permitted to join the partnership.

An ordinary partnership is similar to the sole trader structure, except that there are at least two business owners. Each partner registers as self-employed and submits a separate tax return; the tax and NI obligations are similar to those of a sole trader.

Ordinary partnerships are governed by the Partnership Act 1890 and many partnerships will have a partnership agreement. This sets out the various rights and responsibilities of individual partners, including stating any specified split of profits, decision-making processes and the procedure to take in case a partner leaves the partnership.

A mechanism for dealing with disagreements between the partners or deadlock situations should also be covered in the partnership agreement.

An ordinary partnership set-up is simple and very flexible, and there is no requirement to publish company accounts. An ordinary partnership has no incorporation or ongoing filing requirements, although it may be registered for VAT.

They are ‘transparent’ for tax purposes, and tax liability falls on the partners who are taxed on their share of the profits or losses of the ordinary partnership. Any profits will be shared between the partners and all of the partners are personally responsible for any losses, debts and liabilities of the business.

As a result, a third party could reclaim the whole of any debt from one single partner, in other words creditors may claim a partner’s individual assets to pay back debts, including debts built up by another partner. Should a partner leave the partnership, each of the partners left within the partnership may be jointly liable for the total sum of any debts incurred by the partnership as a whole.

There are a number of advantages of the ordinary partnership structure over that of a sole trader. These include a wider range of skills, greater availability of capital, shared decision-making, and pressure is likely to be reduced with different partners having separate key roles. However, capital can still be limited, with the same problems of raising external capital that a sole trader has.

Also, the more partners there are, the more money there may be available from their combined resources to invest into the business, which can help to fuel growth, and together their borrowing capacity is also likely to be greater.

In an ordinary partnership, the partners both own and control the business. As long as the partners can agree how to operate and drive forward the partnership, they are free to pursue that without interference from any shareholders. This can make a partnership business potentially more flexible, with the ability to adapt more quickly to changing circumstances.

Unless a formal partnership agreement has been drawn up, an ordinary partnership business can easily be dissolved at any time: this gives each partner the freedom to choose to leave if they wish to.

Partnership agreements need to be legally dissolved. If a partnership agreement has to be dissolved on the death of a partner this can cause complications in re-establishing the partnership.

Limited partnerships

A limited partnership is registered in accordance with the Limited Partnerships Act 1907. An English limited partnership must be formed between two or more persons and must carry on a business in common with a view of making profit.

Unlike an ordinary partnership, a limited partnership has two categories of partner:

• One or more general partners who manage the business of the partnership and are liable for all debts and obligations of the firm.
• One or more limited partners who do not participate in the management of the partnership and who have limited liability for the debts and obligations to third parties beyond the amounts they have contributed.

Limited partnerships must be registered at the Registrar of Companies, Companies House . Until registered, both types of partners are equally responsible for any debts and obligations incurred. It is usual to register immediately after the partnership agreement has been signed.

Most limited partnerships are limited to a maximum of 20 partners and each partner must separately register for self-assessment with HMRC. However, under section 717 of the Companies Act 1985 there are a number of exceptions to this rule; they relate almost exclusively to professional partnerships.

Limited liability partnerships

Limited liability partnerships (LLPs) are a popular choice for large partnerships providing professional services, for example, firms of accountants, architects or solicitors. A limited liability partnership does not have shares or shareholders, but instead has members.

An LLP is a body corporate with a legal personality separate from its members, primarily governed by the Limited Liability Partnership Act 2000. LLPs must also comply with various regulations, such as the Limited Liability Partnership Regulations 2001 and the Limited Liability Partnerships (Application of Companies Act 2006) Regulations 2009. These regulations modify and apply parts of the Insolvency Act 1986 and the Companies Act 2006 to be relevant for LLPs.

As an LLP, you must complete the registration process with Companies House. You should also consider creating an LLP agreement with the other partners. This document sets out how the business will be run, the rules for sharing power and the rules for sharing profits. LLPs must nominate a minimum of two designated members who will take on legal responsibilities such as filing the annual accounts. You will be required to file accounts and send an annual return to Companies House.

Accounts will be made public by Companies House, which means anyone can view them. There is substantial paperwork to complete, therefore, employing an administrator to manage this may be appropriate.

Each partner within the LLP must register as self-employed and file an individual tax return. The LLP itself will also file a partnership tax return, showing income and expenditure as well as detailing how profits and losses have been allocated between the members.

If the LLP employs people, it will need to operate a Pay as you Earn (PAYE) payroll scheme, make regular returns and pay income tax and NI that are deducted from the pay of employees to HMRC. If the LLP needs to register for VAT or chooses to register voluntarily, it will also need to submit regular VAT returns and make payments of VAT to HMRC.

The key advantage that an LLP provides over a traditional partnership, is that of limited liability of the members. The liability of each member is limited to the value of their investment in the partnership. That means the members’ personal assets won’t be at risk, unless they are guilty of wrongdoing or have provided personal guarantees.

What is the legal business structure of a private company?

There are currently over 3.5 million limited companies incorporated in the UK. With over two million registered at Companies House, private companies limited by shares are the most frequently used type of company in the UK.

They are more commonly referred to as private limited companies and must have the word ‘Limited’ or the abbreviated suffix ‘Ltd.’ at the end of their name. A limited company has one or more directors, has its own bank account(s), pays its own kind of tax, corporation tax, can be bought and sold in the form of shares, and must be registered at Companies House.

The Companies Act 2006, fully effective from 1 October 2009, made a number of changes making it easier to run a limited company. It is very easy to start a limited company and it can all be done online in just a few hours. However, if you choose not to use ‘limited’ in your company name you must register by post.

The company will usually be registered within 24 hours of receipt of your application, if you do it online; postal registrations can take up to 10 days. It costs £12 to register your company online, and postal registrations normally cost £40, though you can pay £100 for a same-day postal registration if you wish.

The cost of incorporating, that is the name given to the creation of the new limited company, is an allowable expense against corporation tax. When you incorporate a business at Companies House and it is entered onto the register, it becomes separate from the person who owns or manages it – it becomes a legal entity in its own right.

Once you have registered your company, a ten-digit Unique Taxpayer Reference (UTR) will be posted to your company address within a few days. You will need this, so keep it safe. You will also receive a ‘certificate of incorporation’, confirming that the company legally exists. This document also includes the company number and date of formation.

You can set up a limited company in which you are the sole employee and only director. Your company must have at least one director and at least one shareholder, that is you, but it can have several directors and/or shareholders.

Directors collectively agree decisions for the company, must follow its rules and have ultimate responsibility for filing the accounts and ensuring the company pays its corporation tax. Shareholders typically vote on decisions at shareholder meetings, with one share equalling one vote, so majority shareholders have more influence.

A shareholder with more than 25% of the shares is a ‘person of significant control’ (PSC).

As a director you will have some legal responsibilities, including managing accounts and informing other shareholders if you stand to benefit personally from any company transactions.

At the end of your financial year you must report key information to HMRC and Companies House. This ensures that the company pays the tax it owes, and also provides accurate information about the company to its shareholders, investors, creditors and the general public.

You will need to file a company tax return annually, by the deadline given to you by HMRC. You will also need to register for PAYE if the company pays any salaries, including your own as director. Your company may also need to register for VAT, or you may wish to do this even if you don’t have to.

There are two main ways in which you as director can take an income from your company. You can take a salary, or you can pay yourself dividends out of company profits.

Most directors choose a combination of the two, as this can be the most tax efficient. The advantage of a salary, however, is that it entitles you to various other benefits such as the state pension and maternity/paternity benefits and doesn’t require the company to be in profit to pay you, although it is taxed at a higher rate.

One of the main reasons why this particular type of company set-up is so popular is that the amount for which shareholders are liable in the event that the company is wound up is limited to the reserves of the company.

Most contractors choose to operate as companies, as it reduces the risk that their clients will have to treat them as employees for tax and legal purposes. It also protects contractors from heavy personal losses if they are sued by clients.

Forming a company also opens up more ways to fund your business through private equity funding; that is, selling shares in your business.

The formation of a private limited company can suggest that the business has permanence and is committed to effective and responsible management.

It gives both suppliers and customers a sense of confidence and many companies, particularly larger businesses, will not deal with an entity that is not a limited company. Incorporating a business can therefore open up new business opportunities that would not otherwise be available.

What is the legal business structure of a public limited company?

A public limited company (PLC) is a limited liability company, formed in a similar way to a private limited company under the Companies Act 2006, that has chosen to raise capital by offering its shares to the general public.

They both have constitutional documents under the Act, that is, a memorandum and articles of association that have to be filed at Companies House and govern the way the company is run. The shareholders have limited liability for the debts of the business.

There are slightly different requirements for a public company than a private company, for example, a public company must have at least two directors and a company secretary, whereas a private limited company is only required to have one natural director and there is no requirement to have a company secretary.

UK company law says that a PLC must have the PLC designation after the company name and minimum share capital of £50,000.

There are also more complex accounting and reporting requirements for a PLC. If a PLC is listed on a stock exchange, for example, but not limited to:

• the London Stock Exchange ;
• the New York Stock Exchange ( NYSE );
• NASDAQ , an American stock exchange based in New York City;
• the Tokyo Stock Exchange, abbreviated as Tosho or TSE/TYO ; or
• the Bombay Stock Exchange ( BSE ).

There will be further reporting, corporate governance and disclosure requirements placed on it, so that potential buyers can understand the risks of their investment.

The biggest advantage of forming a PLC is that it grants the ability to raise capital by issuing public shares. A listing on a public stock exchange attracts interest from hedge funds, mutual funds and professional traders as well as individual investors. That tends to lead to increased access to capital for investment in the company than a private limited company can accrue.

Another advantage is that a PLC can offer investors a certain amount of liquidity in that investors can sell their shares fairly quickly, particularly if the shares are trading on a stock exchange.

If a PLC is planning to expand its business, it can issue shares to the public to fund activities such as:

• Buying property.
• Paying off its debts.
• Starting a new project.
• Engaging in research and development (R&D).
• Creating a new line of business.

However, PLCs are vulnerable to hostile takeovers, that is a takeover of one company called the target company by another called the acquirer. The takeover is accomplished without the agreement of the target company’s management.

Instead, the acquirer approaches the company’s shareholders directly or fights to replace the management by acquiring shares to get the takeover approved. PLCs are also liable to instability in share valuation as the company is at the mercy of the financial markets, meaning that the value of the company can go up or down.

How should you choose?

Choosing the right legal structure is a necessary part of running a business, whether you are just starting out or your business is growing.

Choosing the right legal structure for your business starts with analysing your business goals. By defining your goals, you can pick the legal structure that best fits your business.

As your business grows, you can change your legal structure to meet your business’s new needs.

Some of the questions to ask yourself might be, am I looking for a business structure that:

• Is easy to set up?
• Has low costs?
• Is easy to run?
• Has flexibility?
• Provides privacy?
• Is tax efficient?
• Provides personal protection?
• Has scalability?
• Is suitable for the future?
• Is easy to exit?

Don’t take this very important decision lightly, and don’t make a choice based on what somebody else has done. Carefully consider the unique needs of your business. You may want to seek expert advice before settling on a particular legal business structure.

Changing to a different legal business structure

Although it is important to get your business structure right from the start, remember that things may change in the future and what is right for you as you are starting out may not be the structure that the mature version of your business needs.

Many famous companies started as sole proprietorships and eventually grew into multimillion-pound businesses, for example, Ingvar Kamprad owned IKEA as sole proprietor building a global furniture business from a single general goods store in rural Sweden.

Many small businesses and self-employed people start out as sole traders because it is the easiest legal structure to set up, especially when you are keen to get going with your new venture or you want to test the market. As the business grows, some small business owners make the change from sole traders to limited companies.

Here are some key steps you will need to take if you are changing your business from a sole trader to a limited company:

• Decide whether you will be the sole director or whether you want to bring in others.
• Tell HMRC your legal structure has changed; this is very important because changing legal structure affects the amount of tax you need to pay.
• Choose a name for your limited company.
• Register your business with Companies House – to do this you will need to create your memorandum and articles of association.
• Set up a new business bank account for your limited company.
• Tell your insurer your legal structure has changed.

It is important to take professional advice about the best option for you and your business if you are considering changing the legal business status.

Why change your business structure?

As businesses grow, evolve and change, it may make sense to change the legal structure of your business. In the vast majority of cases, small businesses change from a simple business structure such as sole proprietor or ordinary partnership to a more complex one such as a limited company or limited liability partnership.

The main reasons small businesses consider changing their business structure are:

• Increasing the number of employees – Employees come with liability and business owners want the protection offered by a limited company or LLP, rather than being personally liable.
• Protection from liability – In addition to the liability that comes with employees, businesses may be liable for injuries to customers, for loans, business debts and for other issues. By switching to a more formal business structure, business owners can protect their personal assets from that liability.
• Allowing outside investment or finance – Anyone who wants to buy a portion of a business as a shareholder, become a partner or lend large sums of money is going to require a formal business structure to protect their investment. A formal business structure such as a limited company or LLP involves setting out clear rights and responsibilities at the outset.
• Expanding client base – Many larger organisations will only do business with limited companies or LLPs; this is usually due to the level of risk involved in the contracts they award.

In conclusion

It is not always easy to decide which legal business structure to choose, as you need to consider your business’s financial needs, risk and ability to grow. Give it careful analysis in the early stages of forming your business, although you can always change the legal business structure if you need to.

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About the author

Evie has worked at CPD Online College since August 2021. She is currently doing an apprenticeship in Level 3 Business Administration. Evie's main roles are to upload blog articles and courses to the website. Outside of work, Evie loves horse riding and spending time with her family.

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