- Steven Moore
Entrepreneurship: The common business formation types
Starting a business involves a lot of decision-making, and one of the most important decisions is choosing the right business formation. There are several types of business formations, and each has its own set of advantages and disadvantages. In this article, we'll briefly discuss some of the most common types of business formations for new entrepreneurs and the pros and challenges of each.
Business Formation Type: Sole Proprietorship
A sole proprietorship is the simplest form of business formation. In this type of business, the owner is the business, and there is no legal separation between the two. The owner has complete control over the business and is personally liable for all debts and obligations of the business.
Pros:
- Easy and inexpensive to set up
- Complete control over the business
- Income and expenses are reported on the owner's personal tax return
Challenges:
- Unlimited personal liability
- Limited ability to raise capital
- Limited life of the business, as it is tied to the owner's lifespan
Business Formation Type: Partnership
A partnership is a business formation in which two or more people share ownership of the business. There are two types of partnerships: general partnerships and limited partnerships. In a general partnership, all partners are equally liable for the debts and obligations of the business. In a limited partnership, there are both general partners and limited partners. General partners have unlimited liability, while limited partners have limited liability.
Pros:
- Easy and inexpensive to set up
- Shared control and responsibility
- Income and expenses are reported on the partners' personal tax returns
Challenges:
- Unlimited personal liability for general partners
- Limited ability to raise capital
- Potential for disagreements among partners
Business Formation Type: Limited Liability Company (LLC)
A limited liability company (LLC) is a hybrid business formation that combines the benefits of a corporation and a partnership. In an LLC, the owners are called members, and they have limited liability for the debts and obligations of the business.
Pros:
- Limited liability protection: Your personal assets are protected from legal actions against the LLC
- Pass-through taxation
- Flexibility of management and ownership
Challenges:
- Potentially Higher taxes
- More paperwork and ongoing maintenance (i.e. quarterly &/or annual regulatory filings)
- Limited life span if a member passes away or otherwise leaves the LLC
Bringing it all together
Ultimately, the choice of a business formation type should be a methodically thought-out process. There are many things to consider including:
The intended product or service offering
Any other future business partners
Intended state/municipality of business operation
Involvement in day-to-day business operations
These are just a few things an entrepreneur will consider. What other important items can you think of?
Coming Up
In our following posts, we'll take a deeper look at each of the three business formation types discussed above. For our next post, we'll review the Sole Proprietorship business formation option. You can decide if this is a good option for your entrepreneurship journey. Stay tuned.
