Choosing Between 5 Major Types of Corporations for Your Business
When starting a new business, one of the most important early decisions is picking the right corporate structure and legal entity type. The most common options entrepreneurs have to weigh include sole proprietorships, general partnerships, limited partnerships, S-corporations, C-corporations, and limited liability companies (LLCs). This comprehensive guide examines the core types of business entities, key differences, benefits and drawbacks, and situations each model best suits.
Sole Proprietorships: Simple Yet Risky
A sole proprietorship represents the simplest business structure where the company is fully owned and operated by one individual. No specific legal business formation filings are required to initiate since the owner reports all income or losses on their personal tax returns.
Pros: Easy and inexpensive to establish, owner has complete control, and no corporate income taxes.
Cons: Unlimited liability, limited options to raise funds, and no perpetual existence beyond the owner’s lifespan.
Best for: Freelancers, consultants, home-based businesses, and early-stage startups that want minimal startup costs and paperwork. The unlimited personal liability makes it very risky for larger-scale operations.
General Partnerships: Shared Ownership and Obligations
A general partnership exists when two or more co-owners decide to open and operate a for-profit business venture together. They agree to share resources, responsibilities, profits, and losses. Partners split management duties equally in most cases.
Pros: Ability to pool more startup capital and specialized skills, shared workload and business risk.
Cons: Partners have unlimited personal liability, greater potential for disputes, and partnerships can be complicated to dissolve.
Best for: Small professional services firms like medical, dental or law practices with 2-20 partners who plan to contribute equal time and capital. Also suitable for small retail shops or restaurants.
Limited Partnerships: Specified Partner Responsibilities
A limited partnership structure designates one partner as the general partner overseeing operations while other partners act as limited partners or silent partners contributing capital. The general partner has unlimited liability while limited partners’ financial responsibility is capped at their investment amount.
Pros: Leadership control for general partner, limited liability for silent partners, and easier to dissolve than general partnerships.
Cons: Restrictions on limited partner involvement, sharing of profits, and extensive filings.
Best for: Businesses where silent investors provide funding while allowing an entrepreneur or management team to run the company. Common in certain types of private equity and hedge fund arrangements.
S-Corporations: Pass-Through Taxation Benefits
An S-corporation offers limited liability protections like a standard corporation but taxation treatment similar to a partnership. Business income or losses pass through to the owners’ personal tax returns. Owners pay taxes on their allocable share of business profits only.
Pros: Liability protection for owners, partnership-style pass-through income taxes, and ability to raise funds through stock sales.
Cons: Extensive corporate filings and records, shareholder compensation requirements, and ownership number limits.
Best for: Medium-sized businesses with under 100 shareholders seeking limited liability with pass-through taxation. Particularly suitable for medical, dental, law firms, and consulting practices seeking these benefits.
C-Corporations: Complex but Flexible
Conventional C-corporations represent a distinct legal entity from the owners, providing complete limited liability. C-corps can sell stock publicly and have greater access to capital markets. However, they face corporate income taxes and double taxation on dividends.
Pros: Complete liability protection, easier access to public capital markets, and perpetual existence even with ownership changes.
Cons: Double taxation of profits and dividends, extensive reporting rules and compliance complexity.
Best for: Large companies planning a future IPO or pursuing rounds of venture capital, private equity, or angel investment. The complex structure works for sizable enterprises.
LLCs: Versatile Pass-Through Protection
A limited liability company (LLC) offers the limited liability protections of a corporation with the pass-through partnership taxation treatment. LLCs avoid double taxation and corporate income taxes. Fewer ownership constraints than S-corps provide more flexibility.
Pros: Liability protection for owners, partnership-style taxation, fewer regulations than corporations, flexible management structures.
Cons: Subject to self-employment taxes, may still require licenses and permits.
Best for: Most small to mid-sized businesses. LLCs offer liability buffers absent in sole proprietorships or partnerships while avoiding extensive corporate compliance burdens.
Choosing the Optimal Business Structure
When deciding the best corporate form and legal business entity, key factors to weigh include risk exposure, ownership flexibility needs, future fundraising plans, and desired tax treatment. Consult attorneys and accountants to ensure you pick the optimal structure based on your state’s specific rules and regulations as well as your unique situation. As a company evolves, the structure can be changed or multiple entities created for specific business units.
Rise of Private Limited Companies
Globally, privately held companies are increasing as a share of total corporations. According to KPMG research, private limited companies accounted for 70% to 80% of all firms in major economies in 2020, up from prior decades. Limited companies offer more flexibility for small and mid-sized businesses versus public firms. Countries like India, UK, Canada, and Australia have seen strong growth in these types of corporations.
Public Companies Declining in Number
While total still substantial, public companies listed on stock exchanges have declined in many markets over the past 20 years. According to the World Bank, the number of listed domestic companies worldwide decreased from 43,054 in 1995 to 41,611 in 2019. Higher regulatory costs and reporting requirements contribute to less public listings. However, total market capitalization of listed firms continues rising.
Partnerships Still Popular in Key Sectors
While not their own legal entity, partnerships maintain popularity for professional services firms, like in the legal, accounting, healthcare, and financial services sectors. Data from the US Census Bureau shows there were over 1.5 million partner owned firms in the US in 2017. Partnerships allow for collaborative ownership and pass-through income tax treatment benefits. They continue meeting needs of many service based businesses globally.
References:
https://web.archive.org/web/20120617104051/http://fds.oup.com/www.oup.co.uk/pdf/0-19-928983-2.pdf
https://web.archive.org/web/20171015152228/https://www.corpnet.com/types-of-corporations/#gfp
https://home.kpmg/xx/en/home/insights/2011/12/private-companies-public-purpose.html
https://data.worldbank.org/indicator/CM.MKT.LDOM.NO
https://www.census.gov/data/tables/2017/econ/sbo/2017-sbo-characteristics.html
