How to Choose a Business Structure

Susan GuilloryUpdated February 5, 2024

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When starting a small business, one of the biggest decisions you’ll make is what business structure to choose. The kind of business entity you select can impact what options you’ll have in a number of areas, including your ability to bring on investors, what you pay in taxes, how protected your personal assets are, and more.Keep reading to learn what a business structure is, common types of business structures, and why it’s important to choose the right structure for your small business.

What Is a Business Structure?

A business structure is the legal structure of a business and refers to how it’s set up and organized. The type of business structure could determine whether or not the business issues stock to shareholders, whether it has more than one business owner, how protected the business owner’s personal assets are, and how it files and pays taxes.

Why Do You Need a Business Structure?

Choosing a business structure can protect both you and your business. For example, choosing an entity type like a corporation or a limited liability company (LLC) can separate you from your business. That means that, if your business were sued, your personal assets wouldn’t be seized to cover the legal costs. The same goes for your debts. If your business files bankruptcy and your company operates as a corporation or LLC, your assets couldn’t be taken to cover your debts.Your business structure could also reduce what you pay in taxes. For example, with S corporations (S corps) and LLCs, profits are passed through to your personal income and you don’t have to pay corporate tax rates on them.And if you decide to bring on investors to help you grow your new business ideas, they may want to work with only certain types of businesses and entities in order to reduce their liability. You’ll want to include details on the business structure you’ve elected in your business plan, which investors will typically want to see.

Common Types of Businesses

There are a few different business structures, and each offers its own benefits and drawbacks.

Sole Proprietorships and Partnerships

If you don’t take any action to set up a specific business entity, your company is, by default, either a sole proprietorship or partnership, depending on whether you have business partners or not.The major benefit of sole proprietorships and partnerships are simplicity. Neither the sole proprietorship nor the partnership requires that any documents be filed or fees paid.The big drawback is that you, as the business owner, are not separate from the business. So if your business is being sued, for example, your personal assets could be taken to cover the business’ debts.Another drawback is that it may be hard to attract investors or be approved for a bank loan, since some investors may feel that a sole proprietorship or partnership provides too much liability and risk to invest in. And some banks may not want to lend to a sole proprietorship or partnership. Recommended: Sole Proprietorship vs. LLC: How to Choose

S Corporations

While there are actually several types of corporations, including the C corp, S corp, B corp, close corporation, and nonprofit corporation, the most common type is the S corporation.The S corp separates you from your business, providing a layer of protection for your personal assets. It also avoids double taxation, which happens when a company’s profits are taxed and then dividends paid to you as a shareholder are taxed on your personal tax returns. In the case of the S corp, all profits are passed through to your personal tax return. This is why an S corp is sometimes referred to as a pass-through entity (this is also true of the LLC). One drawback to an S corp is that if you’re bringing on shareholders, you’ll be limited to 100 shareholders and they must be U.S. citizens. Another potential downside is that the S corp does require a little legwork to set up and maintain. You’ll need to draft your articles of incorporation in the state where you start your business and pay an annual fee to the Secretary of State, as well as prepare corporate bylaws, appoint directors, hold a Board of Directors meeting, and issue stock to shareholders. Check with your Secretary of State’s office to see specific requirements and fees.Recommended: 15 Types of Small Business Loans to Consider

Other Corporation Types

There are a number of other corporation types that you might also wish to consider, depending on your situation. If one of them seems appealing to you, it’s wise to check with an accountant or other professional to advise you about eligibility and filing.

C corp: A C corp can make a profit, be taxed, and be held liable, meaning that its owners cannot be held liable. C corps offer owners the most protection, but they also cost more than other business structures to form and require more record keeping. Other drawbacks of C corps are that they must pay income tax on profits, and profits may be taxed both when the corporation pays income tax and when shareholders pay taxes on dividends.
B corp: Also called benefit corporations, B corps are taxed just like C corps but are different in terms of their purposes, transparency, and accountability. A B corp has some kind of purpose for the public benefit, and the shareholders hold it responsible for achieving this as well as for making profits. The state where the corporation operates may require proof that it’s benefiting the public, as well.
Close corporation: These are similar to B corps, but have less traditional and less formal structures. They may be run by a small group of shareholders without any board of directors, and they’re usually barred from public trading.
Nonprofit: Nonprofit organizations are dedicated to benefiting the public in some way — by promoting charity, religion, political rights, health, education, the arts, science, or some other cause. The organization can file to be exempt from taxes and must follow certain rules in addition to the usual corporation rules when it comes to using any profits it may make.

LLCs

When choosing a business structure, you may also want to consider the limited liability company, or LLC. In many ways, it’s similar to the S corp. It protects your personal assets and your company’s profits can be passed through to your personal taxes. LLC members will, however, need to pay self-employment taxes toward Social Security and Medicare.To benefit from the pass-through tax option that you get with an S corp, you may have to opt to tax your LLC as an S corp. If you think this might be useful for you, speak to an accountant to clarify the process.Another potential advantage is that, unlike an S Corp, an LLC doesn’t limit the number of shareholders you can have.Setting up an LLC is similar in some ways to setting up an S corp. You’ll need to prepare an operating agreement and file your articles of organization with the Secretary of State in the state where you do business. You’ll also have an annual filing fee you’ll have to pay to keep your LLC in good standing.Recommended: Loaning Money to Your Own LLC

LLPs

There’s one more business structure that may be relevant if you’re in certain professional fields like medicine or law: the limited liability partnership, or LLP. With this kind of partnership, general partners have limited liability and are only responsible for their own debts or malpractice concerns.Filing an LLP is similar to filing an LLC. But note that some states — namely California, Nevada, New York, and Oregon — have limitations on what types of businesses can file as LLPs, and there may be certain licenses or permits you are required to have in your field to qualify.

What Type of Business Should You Form?

Choosing a business structure is an important decision, so start by considering what’s most important to your business. If your business has more than one owner, you can rule out the sole proprietorship because it’s only an option for solo business owners. Sole proprietorships can be good if you want to test the waters or run a side business, but are not yet ready to commit to a more serious business entity.Both LLCs and S corps may help you lower what you pay in taxes (though that’s certainly not guaranteed). If you have personal assets you want to protect and keep separate from your business, either of these structures can be a good option.If you want to bring in investors, either an S corp or LLC will provide the limited liability they are probably going to be looking for.Other considerations include how involved a process setting up the business structure will be, as well as annual fees, which can be high. In California, for example, the annual fee for S corporations is $800 or 1.5% of net income, whichever is higher. With the sole proprietorship, you have zero paperwork or fees to pay, though you don’t have that legal protection of your personal assets. If you’re still overwhelmed at the thought of choosing a business structure, filing paperwork, and dealing with the rest of the process, you can hire a registered agent, who handles this paperwork for you. The registered agent can also ensure you pay your annual fees on time and update your annual statement of information document (which essentially checks to see if there have been any changes to your business information or Board of Directors in the last year).

The Takeaway

When you start a small business in the United States, you must choose a business structure, and it’s best not to just let it happen by default. When choosing a business structure, consider how you can best protect your personal assets and your business. If that means electing a different business structure than a sole proprietorship, like the S corp, LLC, or LLP, take the time to go through the process. As your business grows, you may find that you want to look for ways to get funding, and it pays to do due diligence there, too. With Lantern by SoFi, you can receive a small business loan offer from one of the top lenders in our network, all with just a simple application and no obligation to you.

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About the Author

Susan Guillory

Su Guillory is a freelance business writer and expat coach. She’s written several business books and has been published on sites including Forbes, AllBusiness, and SoFi. She writes about business and personal credit, financial strategies, loans, and credit cards.

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