Why Business Structure Matters

The legal structure of your business can affect your role as the owner and your company’s credit rating. When you understand different business structures, you can select the one that makes the most sense for your company. Review the infographic below for more information on four common types of business structures: sole proprietorship, partnership, limited liability corporation (LLC), and corporation.

Why business structure matters for building credit

Why Does It Matter Which Business Structure I Choose?

The key differences among business structures are liability and taxes. In general, the more legally separate the business is from the owner, the less risk the owner assumes. With certain structures, a business can establish its own credit and insure its own risks independent of the owner. By doing this, the company may be better positioned to expand or take on investors.

Types of Business Structures

  1. Sole proprietorship: Business is owned and operated by one person who assumes full liability. No legal distinction between owner and company.
  2. Partnership: Similar to a sole proprietorship but with shared ownership and responsibility. Liability varies depending on the type of partnership.
  3. Limited liability corporation (LLC): Allows for a level of control similar to sole proprietorship, but the business operates as a separate legal entity.
  4. Corporation: Independent legal entity with a formal filing structure. Owners’ personal assets are protected in most cases.

What is the Most Popular Business Structure?

The IRS received 32,783,232 non-farm business tax returns in 2012. Here’s how the numbers broke down:

  • 72 percent of businesses were sole proprietorships, the most popular choice
  • 18 percent of businesses were corporations
  • 7 percent of businesses were LLCs
  • 3 percent of businesses were other types of partnerships

Pros and Cons of Operating as a Sole Proprietor or Partnership

Here are several reasons that sole proprietorships and partnerships are so popular in the United States:

  • They’re the easiest ways to start a business.
  • The business owner or owners retain all control.
  • No paperwork –  just set up your business and go.
  • File taxes with your individual return on Schedule C.

There are risks involved in operating as a sole proprietor or partnership, including:

  • Sole proprietors and simple partnerships come with unlimited personal liability.
  • Sole proprietors and simple partnerships have difficulty accepting outside investors or selling the business.
  • The separate entity created by an LLC or corporation can establish its own credit separate from that of the owners. Sole proprietors and partnerships cannot.

Tradeoffs of Different Business Structures

Most corporations pay taxes at corporate tax rates. Most LLCs, partnerships, and sole proprietorships pay taxes at individual rates, which are usually lower. Here are some other factors to consider:

  • As a sole proprietor, you enjoy simplicity and flexibility. But you also assume personal liability for business debts.
  • When your business is an LLC, you give up some of the flexibility of sole proprietorship but you shield yourself from certain liabilities. The business can be more appealing to creditors and investors than a sole proprietorship.
  • When your business is a corporation, you commit to additional paperwork and expenses. In exchange, the business is a separate entity with limited liability that can add investors or change owners with ease.

Hire a Pro

You and your partners or investors will likely need professional help negotiating, completing, and filing partnership agreements. It may seem like an unnecessary expense, but enlisting someone with experience can save time, money, and relationships down the road. LegalZoom has information on business formation and has partnered with Dun & Bradstreet to offer bundles on select products.

Picking the correct business structure for your company helps you manage one type of business risk, and using D&B Business Monitor can help you manage another: Receive alerts of credit risk increases in a company you work with or a portfolio you monitor. Learn more today.

Photo Credit: criene, Twenty20