Starting a business is both a challenging and rewarding process. Developing a business idea, choosing a name, customizing a website, sourcing your products, and finding your first customers are necessary and often fun parts of running your company. Show
But simply having a website and a logo isn’t enough to start a business. In fact, as a business owner, it’s critical you set up the proper foundation and structure to ensure your venture thrives—and protect yourself if something goes wrong. While it’s not the most glamorous work, business incorporation is the bedrock on which your small business is built. When you incorporate, you establish a legal business entity recognizable by your state and the federal government. Read on to learn the different types of businesses and find out which is best for you. Table of ContentsWhy your business structure mattersThe legal structure of your business determines how you’re taxed, what your liabilities are, and how you’ll secure funding and capital, among a host of other factors. If you go into a business partnership, your structure is going to look different than if you simply start a corporation or limited liability company. Regardless of which legal structure you choose, there are plenty of benefits to incorporating your business, including:
Each business structure offers different funding, liability, ownership, legal, and tax considerations. Types of business structuresWhile each business type has benefits, certain types of businesses are better-suited for different company structures. You can also change your business structure as your business evolves over time, though this comes with additional administrative steps. Sole proprietorshipA sole proprietorship is an unincorporated business without a legal distinction between the company and the individual who owns and runs it. It’s arguably the most straightforward business structure and is simple to set up and manage. Some new ecommerce businesses with low startup costs and a low risk of liability use sole proprietorships. A sole proprietorship can evolve into other types of businesses later—in fact, it has to if you add to your team—but is the fastest and easiest way to start. A sole proprietorship qualifies as a non-employer business. These types of businesses have no paid employees, and they’re one of the most common types of business in the US. About 40% of small business owners have a non-employer business as their main source of income, while 60% use it as a supplementary source. Advantages of sole proprietorship:
Disadvantages of sole proprietorship:Unlimited Personal liability. With a sole proprietorship, taxes are filed under the individual who owns the company. This adds risk because there’s no distinction between the individual and the company, so the individual has unlimited liability for everything the company does. Thus, the individual’s personal assets are on the line. Having exposure to personal liability is something many aspiring business owners are not comfortable with.PartnershipPartnerships are single businesses with two or more owners. Each of these owners or partners contributes to the business through funding, property, labor, skill, or something similar. They also share the profits from the company. There are two types of partnerships:
Partnerships follow a pass-through taxation model. This means individual partners are taxed rather than the business. Taxes are applied based on each owner’s personal income from the business, not the business’s revenue. Advantages of partnerships:
Disadvantages of partnerships:
CorporationA corporation is a business entity separate from a person, so owners are free from personal liability, except for rare and extenuating circumstances. A corporation assumes all the risk, instead of passing it on to the people who own and run it. Business ownership is also more easily transferred for corporations compared to other business structures. Like other types of business, you file your corporation with your state. Each jurisdiction has its own specific parameters for corporations, but pretty much all corporations are required to pay local, state, and federal taxes, each of which are filed separately from shareholders’ taxes. Corporations may or may not pay lower taxes than individuals. This varies by state, so it’s a good idea to compare individual tax rates—for sole proprietorships versus LLCs versus partnerships—with corporate tax rates. In many cases, the corporation will pay less, but consult a tax professional to be sure. Additionally, different types of corporations have different tax structures—for instance, C corporations pay income tax, while their shareholders must also pay taxes on dividends as personal income. By contrast, an S corporation is exempt from corporate income tax. (For more on this topic, check out S Corp vs. C Corp: What Is the Difference?) Advantages of a corporation:
Disadvantages of a corporation:
Limited liability company (LLC)A limited liability company (LLC) is a hybrid business structure, combining the ease of a partnership with the liability protection found in corporations. It’s technically a type of corporation. Limited liability partnerships can also fall under the LLC umbrella. LLC owners, frequently called members, pay taxes on the LLC’s profits directly—in other words, the limited liability structure doesn’t file taxes as a separate legal entity. LLCs with at least two members also have the option to be taxed like partnerships or corporations if they prefer. This taxation election eliminates the separation of business and personal taxes. Limited liability companies are a newer business type, and they’re becoming increasingly popular. According to data from the Internal Revenue Service (IRS), while other corporate structures have declined since the 1980s, LLCs have experienced an upward trajectory. Depending on the state, LLCs may have a limited lifetime. In some jurisdictions, the LLC is dissolved when a member leaves. Ultimately, limited liability companies are a great business structure for a single founder who is just starting out. Advantages of an LLC:
Disadvantages of an LLC:
How to choose your business structureThere isn’t an easy answer or formula for every new business to follow when selecting a structure. Many online retailers start as sole proprietorships or partnerships and wait to incorporate, but the exposure to unlimited personal liability can be scary. Ultimately, the business entity you choose to create is based on a variety of important and personal factors. Contacting an attorney will be the safest way to decide which business structure is best for you and your company. Here are some things to think about with regard to starting your business organization. Personal liabilityOne of the advantages of business incorporation is that it creates a separate entity from you as an individual. This reduces your personal risk for some types of businesses. Some business structures offer stronger protections for owners, like a corporation. Others offer less in the way of personal protection, like a partnership. You’ll have to decide how much personal liability you’re willing to take on.
Learn more: How to Get a Business License: A State-by-State Guide Hiring employeesThe legal structure of your business plays a critical role in staffing decisions. If you’re hiring employees, or have plans to do so, you should know that some types of businesses are limited in this regard. Sole proprietors, for example, can't hire employees. While starting out as a sole proprietor may give you more autonomy and flexibility than other small businesses, you’ll need to file to change your business structure if you plan to onboard any staff. Bringing on partnersLikewise, if you plan to have a partner in your business, you’ll need to choose a business structure that can support a business partnership. So instead of a sole proprietorship, you’ll likely look to set up a partnership, an LLC with multiple members, or a corporation. General partnerships also fall under this category. Business fundingYou may come to a point in your business where you need funding for product development, store expansion, inventory investments, or other necessary expenses. There are multiple ways to raise capital for your online business, but success depends on many factors—one of those being your business structure and history. When you incorporate, you can build credit and a financial history for your business. Potential lenders, investors, and other sources of capital will look at this information to determine your business’s eligibility for funding. A strong history and credit standing will increase your chances at securing financing and low interest rates. With funding from Shopify Capital, you can make your next big move with confidence. Incorporating your businessThe act of incorporating your business requires a few administrative steps. You can do everything yourself, get help from an expert, or outsource the entire process. If you want to hire an expert, check out Shopify Experts to find qualified pros and sales tax experts who can help. At a glance, you’ll need to take the following steps to officially incorporate your online business: Decide where to incorporate your businessFor some business owners, where you incorporate is going to be straightforward. If you operate and sell locally, you’ll likely opt for the state where you do business. But if you have plans to sell across the country, or even internationally, there’s more to this decision than you might think. Remember, you’ll still need to file your personal tax returns, regardless of your business’s legal structure. Each state has its own set of requirements for different types of businesses, as well as its own application, taxation, and administrative parameters. Check your state’s requirements and apply for your state license. Choose your business nameYour business name (try our business name generator), or a variation of it, will likely be how you’re known to the public. For example, you might refer to General Electric as “GE,” but its actual corporate name is still General Electric. If you’re feeling stuck on your name, you can use this guide to choosing a business name to spark some ideas. When you do have an idea you like, perform a search in your state’s database to ensure no one else has claimed it before you. Apply for your federal employer identification number (EIN)Your federal employer identification number, or EIN as it’s commonly known, functions similarly to how your Social Security number functions—you use it when you file paperwork and taxes with the government. This is how the government identifies your business. You need your EIN to incorporate your business. To register for an EIN, fill out this form on the IRS website. You’ll get your EIN immediately. File your paperwork and/or articles of incorporationOnce you have your EIN and a chosen name, you can file the paperwork with your state to make it all official. If you’re filing for a corporation, you’ll need to include Articles of Incorporation with this application. Essentially, all of this administrative paperwork contains information about your company, its founders/partners/members, and its shareholders. These documents make your business official. Remember, you’ll still be required to file your personal tax returns in conjunction with your state and country laws. Take the next step with ShopifyIncorporating your business makes it official in the eyes of the government. You’ll protect your personal assets, build credit and history for your company, and even enjoy lower taxes in some cases. But the best benefits of business incorporation are perhaps intangible. Incorporation transforms your idea into a real, official business—the rest is up to you. If you want to document your business strategy, use our business plan template. It’ll help you clarify ideas, map out financial projections, and more when planning your new business.
The four main types of business structures are sole proprietorship, partnership, corporation, and limited liability company (LLC).
Both LLCs and corporations offer limited liability for businesses. However, an LLC is better for owner-operated small businesses looking for more flexibility and less red tape, while a company looking to grow and raise money should structure itself as a corporation.
Each business type has its pros and cons regarding taxes. For instance, sole proprietorships pay self-employment taxes, while corporations do not. However, unlike corporations, sole proprietorships can lower their tax burden through itemized deductions. |