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Understanding Business Structures: A Guide by O1ne Mortgage

When starting or expanding a business, the structure you choose can significantly impact your profits, legal risks, and growth potential. At O1ne Mortgage, we understand the importance of making informed decisions. Here’s a breakdown of the different business structures to help you decide which one suits your needs best. For any mortgage-related inquiries, feel free to call us at 213-732-3074.

What Is a Corporation?

A corporation is a business entity that exists independently of its owners, reducing their liability risk. Small businesses typically use one of three types of corporate structures: C corporation, S corporation, or limited liability company (LLC).

C Corporation

A C corporation is the standard corporate structure. Incorporation involves filing documents with your state. Corporations can issue stock to an unlimited number of shareholders, providing flexibility to raise money from investors.

S Corporation

An S corporation is similar to a C corporation in many respects, including liability protection and state filing requirements. However, S corporations differ in tax treatment and share issuance. Profits are taxed as personal income, avoiding the double taxation faced by C corporations. S corporations are limited to 100 shareholders, who must be U.S. citizens or residents.

Limited Liability Company (LLC)

An LLC combines the tax advantages of a sole proprietorship or partnership with the liability protection of a corporation. LLCs are typically easier and less expensive to establish and operate, with fewer documents to file and regulations to comply with. Owners are not personally liable for the business’s debts or legal issues, and profits and losses are reported on personal tax returns.

Pros and Cons of a Corporation

Pros

• Owners are protected from personal liability.
• Corporations can continue to exist even if owners leave the business.
• More opportunities to raise financing from investors.
• Banks are more willing to give loans to corporations.

Cons

• Greater complexity and more paperwork.
• Time-consuming legal regulations to follow.
• C corporations face double taxation.
• S corporations are restricted to 100 shareholders.

What Is a Sole Proprietorship?

A sole proprietorship is a one-person business considered the same legal entity as its owner. It is the most basic form of business. If you start a business without registering as another type of entity, you are a sole proprietor by default.

Pros and Cons of a Sole Proprietorship

Pros

• No need to register as a business entity or file incorporation documents.
• Run the business as you see fit without answering to partners or shareholders.
• Income flows through to your personal income, simplifying tax filing.

Cons

• Personally responsible for business debts and legal problems.
• Personal credit information may be used for business credit applications.
• Difficulty in obtaining business financing.
• Banks are less willing to give loans to sole proprietorships.

What Is a Partnership?

A partnership is a business with two or more co-owners, typically governed by a partnership agreement. Common types include general partnerships and limited partnerships.

General Partnership

A general partnership is similar to a sole proprietorship but with two or more partners. Partners are personally responsible for business debts and legal liabilities, and profits are shared among them.

Limited Partnership

A limited partnership includes general partners who handle daily operations and limited partners who are typically investors. Limited partners are protected from personal liability and are not involved in daily operations.

Pros and Cons of Partnerships

Pros

• Relatively easy to structure with two or more owners.
• Less paperwork and fewer compliance requirements.
• Limited partners are shielded from personal liability.
• Typically pay less in taxes than corporations.
• Easier to get business loans compared to sole proprietorships.

Cons

• General partners are jointly and individually responsible for debts and liabilities.
• Personal disagreements can destroy the company without a solid partnership agreement.

Which Business Structure Should You Choose?

The right business structure depends on various factors, including your personal assets, business risk, tax situation, growth plans, financing needs, and future vision. Here are some scenarios to help you decide:

Scenario 1

You’re fresh out of college and start a part-time side gig selling handmade clothing on Etsy. You work out of your apartment and never meet customers in person.

Assessment: Since you don’t have a store or work with customers in person, the risk of a lawsuit is slim. You don’t own a home and have few assets to protect. Your business is part-time, and you don’t plan to seek loans or investors.

Business structure: Keep it simple with a sole proprietorship. You can always change your business structure if the venture grows.

Scenario 2

You’re launching a restaurant with your best friend. You’ve studied business, while she’s worked in restaurants her whole life. You plan to run it together; your wealthy uncle has agreed to finance the startup.

Assessment 1: Your uncle is contributing money but nothing else. You want to keep things simple in terms of paperwork and taxes.

Business structure 1: A limited partnership with your uncle as the general partner will protect his assets while keeping him out of day-to-day decisions. Minimal documentation is required, and you won’t have to file separate business taxes.

Assessment 2: Restaurants are risky, capital-intensive businesses. A customer could slip, fall, and sue you. Even with your uncle’s money, you might need a loan to tide you through a slow season.

Business structure 2: Incorporating may make more sense. You and your partner can protect your assets and have an easier time getting business loans or lines of credit.

Scenario 3

You’ve started what you’re sure is the next big social media platform based on code you wrote in college. Private investors have already shown interest, and you think you can get venture capital. You need to hire quickly to build out your idea. Even though you can’t pay employees much right now, you have big dreams of going public and becoming the next billionaire.

Assessment: Any business based on intellectual property is vulnerable to lawsuits. You want to raise large sums of money and need a way to compensate employees without cash. You have big dreams.

Business structure: A C corporation offers the most protection for your personal assets. You can issue stock to your first employees to make up for their low wages. As a C corp, it will be easier to get business loans, venture capital, and private investors—and eventually go public.

The Bottom Line

The business structure you select affects your legal and financial liability, taxes, fundraising potential, and more. Before making a decision, consider consulting with a small business expert. Small Business Development Centers and SCORE offices nationwide work in partnership with the Small Business Administration to provide free guidance from experienced business owners and advisers.

No matter what form of business you choose, your personal credit is a factor when you’re starting out. Check your credit report and credit score before applying for a business credit card in your company’s name. The card issuer will report your account to the three business credit bureaus: Experian, Dun & Bradstreet (D&B), and Equifax—your first step in establishing business credit.

For any mortgage-related needs, call O1ne Mortgage at 213-732-3074. We’re here to help you make the best financial decisions for your business.

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