Looking to start your own business? Congratulations! You're onto something big — entrepreneurs like yourself are fueling the economy. To help you get started, we'll explain the seven most common types of business. If you're starting your own business, you'll want to create a business plan to help you better outline your goals before committing to one of the business types below.
What type of business should you start?
One of the first challenges new entrepreneurs face is deciding what type of business they should register. Although there are several different types of businesses, choosing one doesn't need to be difficult. Here are the 7 most commonly-used business types and some questions to help you pick which business type is right for your startup.
The 7 most common types of businesses:
- Sole Proprietorship: The simplest type of business. Sole proprietorships are owned by a single person and are very easy to set up.
- Partnership: A type of business owned by two or more people who share responsibilities and profits.
- Limited Partnership: A type of business partnership, often between business operators and investors. General Partners run business operations, while Limited Partners provide investments.
- Corporation: A type of fully-independent business with shareholders. Requires a lot of work to set up, so is less common for small online businesses.
- Limited Liability Company (LLC): A mixture of a partnership and a corporation, designed to make it easier to start small businesses. One of the most popular business types.
- Nonprofit Organization: A type of business that uses its profits for charitable purposes. Nonprofits are tax-exempt, but require a lot of paperwork and must follow special rules.
- Cooperative (Co-op): A business owned and operated for the benefit of the members of the organization that use its services. Most common for services, but there are online co-op businesses.
Choosing the right kind of business
A startup's choice of business structure can have long-lasting effects on the way the business is run and operates, including how it files taxes and whether it can hire employees. To help you decide, we've created a flowchart to walk you through the decision-making process:
Decisions you'll need to make when choosing a business type:
- Debt and Liability: Most small businesses and startups accept the personal liability associated with a sole proprietorship or partnership as a necessary risk of doing business. If you're in a high-risk industry (such as selling CBD or firearms online) or simply want to keep your business and personal matters private, you can limit personal liability by filing for a more formal business structure. The downside is that this typically takes more paperwork, costs more to register, and may have greater reporting or upkeep requirements than simpler business types.
- Filing taxes: To oversimplify a bit, you have two options when it comes to filing your business taxes. You can file business profits/expenses on your own personal tax returns, or you can have your business file taxes separately as its own entity. Most small business owners prefer the simplicity of filing taxes on their own returns, but filing business taxes individually can help you keep your personal and business finances separate.
- Partners or Investors: If you're starting your business with a partner or private investor, you won't be able to form a sole proprietorship. You can choose between a partnership, where all responsibilities and liability are shared equally, a limited partnership which lets you dictate responsibilities and liabilities for individual members, or form an LLC to protect all members from personal liability.
- Hiring employees: Some of the simplest business types like sole proprietorships can make it difficult to hire employees down the road. While it's possible to change your business type to grow with your business, if you already have employees or plan to hire employees it may be better to future-proof with a more formal business structure like an LLC or corporation.
- Are you starting your business for profit or to help a cause? If you're just concerned with helping others and aren't operating for profit, forming a nonprofit can grant you tax-exempt status - although there's a lot of paperwork required.
- Will your company be owned and operated democratically by its members with no single owner? Known as a "Co-op", this type of business tends to be rare.
After you've answered these questions and have decided which type of business is best for your startup, the next steps are dependent on your state and local laws and ordinances, as you may need to fill out additional forms specific to your location and type of business. There are a number of books and resources for this. Many of them recommend using the Small Business Association as the starting point since they maintain local offices. Finally, check your local and state laws regarding running a business out of your home, as zoning laws can sometimes be an important factor in deciding which type of business you want to create.
Sole proprietorships are the most common type of online business due to their simplicity and how easy they are to create. A sole proprietorship is a business owned and operated by a single person, and require no registration. If you're operating a one-person business, you're automatically considered a sole proprietor by the government. However, depending on your products and location, you may need to register for local business permits with your city or state.
An important thing to note is that there isn't a legal or financial distinction between the business and the business owner. This means that you as the business owner are accountable for all of the profits, liabilities and legal issues that your business may encounter - not typically an issue as long as you pay your bills and keep your business practices honest. If you're starting an ecommerce business by yourself, a sole proprietorship is probably the best type of business for you. If you're starting a business with one or more partners, keep reading!
Two heads are better than one, right? If you're starting your business with someone else, a partnership may be the right choice. A partnership offers many benefits - you can pool resources and knowledge with another, secure private funding, and more. Just keep in mind that within a partnership responsibilities and liability are split equally among each member. However, there are several types of partnerships (such as limited partnerships, discussed in the paragraph below) that will allow you to define the roles, responsibilities, and liability of each member.
A partnership does require that you register your business with your state and establish an official business name. After that, you'll then be required to obtain a business license, along with any other documentation that your state office can help you with. Beyond that, you'll also need to register your business with the IRS for tax purposes. Although this may seem like a complicated process, there are lots of benefits to a partnership, so if you're looking to have a co-owner, don't be afraid to go for it - many online companies are formed using partnerships. Having someone to help share the work of starting a new business is definitely worth the extra paperwork.
A limited partnership, or LP, is an off-shoot version of a general partnership, and while it may not be as common, it's a great bet for businesses who are looking to raise capital from investors who aren't interested in working the day-to-day aspects of your operations. With a limited partnership, there are two sets of partners: The General Partner and the Limited Partner. The general partner is usually involved in the everyday business decisions, and has personal liability for the business. On the other hand, there's also a limited partner (typically an investor), who is not liable for debts and don't partake in regular business management of the company. Just like a general partnership, if you enter an limited partnership agreement, you'll need to register your business with the state, establish a business name, and inform the IRS of your new business. Again, this option is the most common for those looking for investment dollars, so keep that in mind when exploring your partnership options.
A corporation is a fully independent business that's made up of multiple shareholders who are provided with stock in a the business. Most common is what's known as a "C Corporation," which allows your business to deduct taxes much like an individual - the only problem with this is that your profits will be taxed twice, both at the corporate level and at the personal level. Don't let this fact deter you, however - this is extremely common, and if you currently work for a company with multiple employees, that's likely the business structure they're using. Most likely, if you're starting off as a smaller business, particularly one that only operates online, declaring yourself as a corporation wouldn't be appropriate. However, if you're already an established business with several employees, listing your company as a corporation might be the correct move. You'll need to file very specific documents with the state, followed by obtaining the appropriate business licenses and permits.
Limited Liability Company (LLC)
Next on our list of business types is a Limited Liability Company, better known as an LLC. An LLC is a newer type of business that is a blend between a partnership and a corporation. Instead of shareholders, LLC owners are referred to as members. No matter how many members a particular LLC has, there must be a managing member who takes care of the daily business operations. The main difference between an LLC and a corporation is that LLCs aren't taxed as a separate business entity. Instead, all profits and losses are moved from the business to the LLC members, who report profits and losses on a personal federal tax return. The nice thing about pursuing an LLC is that members aren't personally liable for business decisions or actions of the company in question, and there's far less paperwork involved in creating an LLC as compared to a corporation. LLCs are another of the most common types of online businesses, since they allow small groups of people to easily form a company together.
A nonprofit organization is pretty self-explanatory, in that it's a business organization that's intended to promote educational or charitable purposes. The "non-profit" aspect comes into play in that any money earned by the company must be kept by the organization to pay for its expense, programs, etc. Keep in mind that there are several types of nonprofits available, many of which can receive "tax exempt" status. This process requires filing paperwork, including an application, with the government for them to recognize you as a nonprofit organization. Depending on the parameters of your new business, they'll be able to tell you which category you best fall under.
The last on our list is what's known a cooperative, or a business that's fully owned and operated for the benefit of the members of the organization that use its services. In other words, whatever is earned by the cooperative is then shared among the members themselves, and aren't required to be paid out to any external stakeholders, etc. Unlike other types of businesses, which have shareholders, cooperatives sell shares to cooperative "members," who then have a say in the operations and direction of the cooperative itself. The main difference in the process of becoming a cooperative, as opposed to the other types of businesses listed, is that your organization must create bylaws, have a membership application and have a board of directors with a charter member meeting. This is one of the least common types of online businesses, although online cooperatives do exist, such as the outdoor goods store REI.
There are a number of good resources that cover the intricacies of starting a co-op, such as this one.
Types of Business Ownership
The business structure that you choose for your startup can impact your own role within the company. As the business owner, here's how each business structure will impact your overall role and daily activities:
Owning a Sole Proprietorship Business
Owning a business as a sole proprietor is a one-person show. Many sole proprietors handle every aspect of their business, covering everything from product selection to customer service. While owning this type of business can be very hectic, it gives you sole control over all business decisions. The downside is that sole proprietorships tend to have a hard time scaling, since the business structure doesn't easily allow the hiring of employees. If you're running a sole proprietorship, be prepared to learn a LOT of new skills, since you won't be able to rely on others - at least not until you've hired them as contractors. Also, be aware that you won't be able to sell your sole proprietorship without the buyer forming a new business.
Co-owning a partnership
Having a partner can help you split responsibilities among members, allowing you to focus on your strengths. While daily life will be similar to running a sole proprietorship, you'll have someone there to help share the workload. However, if you're starting a partnership with a single partner and plan to share ownership equally, be aware that you're setting yourself up for a lot of tied votes. We recommend that all partnerships begin with a formal partnership agreement detailing the roles and responsibilities of each member, as well as a plan for how to resolve tied votes, disagreements, or other disputes.
Becoming a member of a Limited Liability Corporation
Your role within a Limited Liability Corporation can vary. If you're setting up an LLC alone or with a partner, your daily life will be comprised of mostly hands-on tasks, similar to a sole proprietorship. However, roles within LLCs are flexible, and membership within an LLC can resemble an employer-employee business.
Running a Corporation
While your responsibilities can vary widely based on your role in the corporation, it's likely that you'll be spending a lot more time on high-level strategy than hands-on operations. If you're a small business owner looking to incorporate, be prepared to spend a lot of time on the more administrative side of running a business. Corporations are subject to more strict legal and reporting standards, meaning more time spent on beauracracy and less time spent performing the daily operations of the business.
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