Business Structure

Choosing an appropriate business structure is vital as it will affect how much you pay in taxes, your ability to raise money, your personal liability and the amount and types of paperwork you will need to file.

This important step will need to occur pretty early as it is required before you can register your business and even though you can convert to a different business structure in future, there may be restrictions and/or complications such as tax consequences. If you are really lost it may be worth seeking external expertise in the form of a business consultant, attorney or accountant.

Below is a list of the most common business structures.

Sole proprietorship/sole trader

If you conduct business activities and don’t register as any other kind of business you are automatically considered a sole proprietorship from a business structure perspective. This is practically the simplest form of business structure and gives you complete control of your business and a minimal amount of paperwork, however trading under this structure does come with its limitations.

For instance this structure means that your business assets and liabilities are not separate from your personal assets and liabilities. Leaving you at risk of being held personally responsible for the debts and obligations of the business and having to liquidate personal assets in order to pay such obligations.

This is a term known as unlimited liability and thus if your business concept is in any way risky, it is best to steer clear of this business structure and explore other options. However a relatively low risk organisation can typically use this form of business to test their idea and gain traction before transitioning to a more formal business entity.

In general the advantages and disadvantages of the Sole Proprietorship business structure are as follows:

Setting up a sole proprietorship

As mentioned a sole proprietorship is the easiest entity to set up, but there are still a few steps you need to be aware of before diving in:

• Choose a unique business name to register – You will need to decide on an appropriate and relevant name for your business and ensure that this name has not already been registered as a business by someone else (so you can avoid any potential future legal action). To do this you need to conduct a name search with the relevant government entity in the jurisdiction you are looking to register in. Often there is a cost associated to this, but it is a relevant and important due diligence step to avoid any expensive litigation cases in future.
• Register your business – Once you have conducted the name search and found a relevant and unique business name, it is time to register that with the governmental body that oversees the location which you will be doing business in. To do this you will need at the very least a business address and a description of your business. There may also be other requirements to register your business depending on the rules of the jurisdiction, it is therefore always worth reading up on the relevant governmental website.
• Apply for appropriate licenses, permits and tax numbers – Once registered you will need to understand the relevant licenses and permits that relate to your idea. This is often dependent on the nature of the business you are seeking to run. For example a restaurant would need to apply for permits to sell food and potentially a liquor license if it wished to serve alcohol, yet other types of businesses may require far fewer licenses and permits. You are also going to have to apply for a sales tax number if applicable.
• Keep on top of the administration – Depending on where you have registered, some jurisdictions have rules around reports that need to be submitted and you may also need to renew licenses and permits. It pays to keep an accurate record of this as often you don’t get a reminder and you need to ensure you are running your business within the governmental guidelines at all times.

Partnership

Partnerships are a simple form of business structure in which two or more people can own a business together. There are two kinds of partnerships: limited partnerships and limited liability partnerships.

Limited partnerships have only one general partner with unlimited liability whilst all other partners have limited liability (and usually as a result limited control). Such agreements are governed by a partnership agreement which sets out the levels of control, voting rights and interests of each partner who is party to the agreement.

Limited liability partnerships are similar, but give limited liability to all partners under the agreement meaning the debts and obligations of the business are those of the business alone and each partner is considered a separate entity. A limited liability partnership therefore protects each partner from debts against the partnership and thus they won’t be responsible for the actions of other partners.

In general the advantages and disadvantages of a partnership are as follows:

Setting up a Partnership

When setting up a Partnership, you have to follow many of the same steps as above when setting up a sole proprietorship including:

• Choosing a unique business name to register – As above you will need to decide on an appropriate and relevant name for the business and ensure that this name has not already been registered.
• Register your business – Registering a partnership is slightly different to registering a sole proprietorship, but is still relatively straightforward. You will again need to see what the relevant governmental body requires for registration.
• Apply for appropriate licenses, permits and tax numbers – As described above.
• Keep on top of the administration – As described above.
• Complete a partnership agreement – Slightly different to the process of setting up a sole proprietorship, in a partnership, you should look to draw up a partnership agreement (such an agreement is mandatory in the case of a limited partnership). This agreement is designed to set out the duties and responsibilities of each partner as well as stipulating how decisions will be made and how the partnership will end. There are also many other general and legal provisions that could be included to set out items such as liability, capital contributions, profit distribution, ownership of assets, confidentiality, non-solicitation, non-competition and dispute resolution. It is strongly recommended that some legal counsel is sort when attempting to derive a partnership agreement, as this will be used and interpreted by the courts should something go wrong.
• Open a business bank account – This could also be done as a sole proprietorship and is recommended as it keeps your business finances separate from your personal finances and ensures you can always look at the relevant financial information to your business. It is however a necessity when it comes to a partnership. A business bank account provides transparency to all partners and accountability for expenditures. To set up a business bank account you will typically need proof of your business name and registration and photo identification. All authorised signing officers of a partnership must also be present and sign on to the account before they will be permitted to sign cheques or access the account. Depending on which banking institution you go with, there may also be more requirements and paperwork to get your business bank account off the ground.

Limited company

A limited company aka a limited liability company is different to that of a partnership and a sole trader as it registers the company as a completely separate entity to that of the owner(s). In most instances therefore registering your business as a limited company will protect you from personal liability and thus your personal assets (house, car etc) won’t be at risk in the event your company faces bankruptcy and/or lawsuits.

Limited companies can be a good choice of business structure for medium or high risk businesses in which the owner(s) wish to separate the liability of the business from their own.

In general the advantages and disadvantages of setting up a limited company are as follows:

Whilst the entity is separate from the owners from a legal perspective, the corporate veil can be lifted in rare circumstances (such as fraud or wrongful trading) which may result in the owners being subject to personal liability.

Setting up a Limited Company

You will have to follow many of the same steps listed above concerning the setup of a partnership/sole proprietorship, however you will also have to consider the following:

• Decide where to incorporate – You will need to decide where you wish to incorporate your business and what rules govern its incorporation. Certain jurisdictions may have very cumbersome reporting requirements.
• Complete your articles of incorporation – This documentation is designed to establish the legal existence of your organisation as well as setting the rules for its shareholders, directors and officers.
• Prepare and submit an incorporation agreement – This is an agreement to be signed by each person who is forming the company who will typically become the shareholders and directors once the company is incorporated. Once the documentation is complete it can then be submitted to the relevant governmental body for processing (this stage typically incurs a fee).
• Check what records you need to keep – You will need to keep on top of the records and reporting requirements placed on your company following incorporation to ensure you comply with any regulatory requirements.

Corporation

A corporation (also known as a Public Limited Company PLC) like a limited company is an entity that is separate from its owners. Corporations offer the strongest protection from personal liability, but the cost to form such an organisation is higher than other business structures and the ongoing cost of paperwork, extensive record keeping and reporting can be cumbersome. Corporations have a completely independent life to their shareholders and should a shareholder leave the company or sell their shares, the company can continue relatively undisturbed. Corporations also have the advantage of being able to raise capital through the issuance of shares to the public. A Corporation is therefore a good choice for medium or high risk businesses, or businesses that plan to go public or eventually be sold.

In general the advantages and disadvantages of a corporation are as follows:

Setting up a corporation

Setting up a Corporation follows many of the same steps as setting up a Limited Company, however you will also have the added step of putting together a public offering of shares. Below is a step by step process to setting up a corporation.

• Select your Corporate name – As is the case for all of the previous mentioned business structures you will need to choose the name of your business and it must not match or be similar to that of an existing corporation.
• Articles of incorporation – Like with a Limited company, you will need to have the drafted articles of incorporation to set out the rules of the organization and establish it as a legal entity.
• Shareholders Agreement – If you wish to place restrictions on who can become a new shareholder and/or set provisions on how existing shareholders must behave, you may wish to put together a Shareholders’ Agreement to govern this.
• Obtain required licenses and permits – As before, dependent on the nature of your business, there may be permits and/or licenses required in order to operate
• Check ongoing documentation and tax obligations – With a Corporation there is significant reporting requirements and you will need to ensure you are adhering to them. Tax obligations can also vary dependent on which corporation type you choose (a corporation can be taxed as an S corporation in which corporate income, losses, deductions and credits are passed to shareholders for tax purposes or a C corporation in which the corporation itself is also taxed).
• Stock issuance – Stock certificates and offerings will need to be prepared and executed and the corporations share ledger which tracks who owns the shares will need to be consistently updated.

Non profit

Non-profit organisations are organised to do charity, education, literary or scientific work. Their work benefits the public and therefore they receive tax exempt status, meaning they don’t pay state or federal taxes on any profits they make.

Non –profits need to follow rules very similar to a regular corporation, however they also need to follow special rules around what they do with the profits they earn e.g. such profits can’t be distributed to its members.

In general the advantages and disadvantages of a non-profit business structure are as follows:

Setting up a Non-Profit

Setting up a non-profit is very closely aligned with the process of setting up a limited company or corporation, but you will also need to file some more paperwork in order to retrieve your tax exempt status and also apply for any grants and/or funding that may be available. Below is a step by step breakdown of how to go about setting up a non-profit:

• Select your name – Again you will need to choose the name of your non-profit and it must not match or be similar to that of an existing organisation.
• Articles of incorporation – Like with a Limited company or Corporation, you will need to have the drafted articles of incorporation to set out the rules of the non-profit and establish it as a legal entity in the jurisdiction you choose.
• File for tax exempt status – As previously discussed, your non-profit will be subject to favorable tax status; however you will need to apply for this through the relevant government entity.
• Check ongoing documentation and reporting obligations – As mentioned, a non-profit is subject to significant reporting requirements and you will need to ensure you are adhering to them. It is best to check the relevant governmental website and documentation to ensure you are in compliance with these reporting requirements each year.

You may also like

Commercial Law Business Plan Managing the Money Sales