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There’s a lot to think about when first starting your business. Some questions you may be asking include: Who is my audience, how will I diversify my revenue, and which legal structure will I operate under? It may be tempting to go with “sole prop” and push off registering to another day, but we’re not exactly advocates of this approach, especially if you know you want to scale.
While the business entity you select is not necessarily set in stone—you can change it down the line, with some work—it does direct your path. And in those early days, direction is everything. Registering your business also has implications for building business credit, getting funding, how much you’re personally liable for your business’s activities, and how long you’ve been in business on paper (which is what lenders care about). For example, if you’ve been in business since 2017, but only registered in 2022, you wouldn’t qualify for loans that require at least two years in business (like SBA 7(a) loans, for example).
Here are the types of business entities you can choose from, the implications of each one, and how to choose the right one for your small-to-medium-sized business (now and down the line).
Types of business structures and their implications
| Entity | What it means | Benefits + implications |
| Sole proprietorship | This is a non-registered label for anyone earning money from a business venture without having formed a legal structure. | Being a sole proprietor helps you start your business ASAP while you get all the logistics set up.
However, as the Small Business Administration (SBA) says, “You can be held personally liable for the debts and obligations of the business.” In addition to the unlimited personal liability, it’s hard to get a business loan as a non-registered sole proprietor. |
| Partnership | When 2+ people own a business together, they can form one of two types of partnerships: A limited partnership (LP) or a limited liability partnership (LLP). | In an LP, one general partner has unlimited liability, while the other limited partners have limited liability. All partners pay personal income taxes on profits, but the general partner also pays self-employment taxes.
In an LLP, all partners have limited liability. The partnership agreement protects each partner from general partnership debts. |
| Limited liability company (LLC) | This entity protects your personal assets from liability in the event of a business lawsuit or bankruptcy. You can be a single-member LLC or regular LLC with employees. | You pay personal taxes on your profits and losses.
LLC members must pay self-employment taxes, but do not have to pay corporate taxes. |
| Corporation | Also called a C corporation or C corp, this is an entity that’s separate from its owners. | Profits are taxed through the corporation.
Owners are highly protected from personal liability, but it’s a costlier structure than an LLC due to additional corporate taxes. If a C corp pays dividends to shareholders, those shareholders have to pay additional taxes on the money. C corps can raise funds, go public, and easily be sold down the line. They must have shareholders, directors, and officers. |
| S corporation | Also called an S corp, this is a type of corporation that avoids corporate taxes. | Tax implications for S corps vary by state, but can generally “pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes,” according to the Internal Revenue Service (IRS).
Every S corp must have a board of directors. |
Other, less common business entities include B corps (benefit corporations, which strive to benefit the public in addition to achieving profit), close corporations (less traditional corporations with no board of directors), and nonprofit corporations (tax-exempt companies that do charity, education, religious, literary, or scientific work).
How do you choose the right legal entity for your business?
The legal structure you choose is ultimately dependent on the type and size of business, tax and funding needs, and other unique aspects only you know. However, you can ask yourself some questions to guide your decision:
- How many shareholders will your business have? Some entities have restrictions on the number of shareholders.
- Will you require funding from investors? Certain entities provide a more favorable investing environment.
- How risky is your industry? Certain entities provide more liability protection than others.
- How do you want your profits to be taxed? The IRS treats each entity differently, sending profits through to personal tax returns or the corporation itself. Some structures receive double taxation.
It’s a good idea to speak with a business attorney before deciding on an entity so you can optimize your SMB from the get-go.
How did real business owners choose their legal structure?
Josh Meunier, business management consultant with WinRate Consulting, says he initially chose an LLC because it “provides more security from the risks associated with the business boiling over into someone's personal life.” He adds that the entity also helped stabilize the company structure with operating agreements (aka a document outlining company functions and financial terms) if there are multiple partners. Meunier says this helped to “make sure that proper expectations of the relationship are set by both parties.”
Haris Bacic, co-founder and CEO of PriceListo, chose an LLC for its “flexible management structure.”
Theresia Le Battistini, CEO and founder of Fashion League, chose an LP. She says, “As a technology company that necessitates the hiring of skilled workers to build the game, I needed the easy ability to raise funds. A limited partnership is called limited because it limits the liability and tax burden of those who invest in the business. Since this game didn't need investors to also be involved in daily operations, the choice of a limited partnership was ideal for all involved.”
Can you combine different business entities?
If you have multiple businesses, you can create a holding company that serves as a “parent” or “umbrella” to other corporations or LLCs.
Let’s hear from Meunier again, who actually created an S corp to hold multiple LLCs. “Once we moved into an S corp situation because of our profitability, we restructured to have our holding company own 100% of each individual LLC, further removing us from risk.”
Bear in mind that you may have to pay taxes on both business entity types, and you may have to maneuver through separate liability exposure.
Changing a business entity while you’re in business, explained
Whether your business activities change, your plans for funding shift, or another pivot occurs, you can always change your business entity after you initially register. This requires filling out legal documents, filing and paying any required fees based on state law, transferring liabilities and assets, and ending the previous entity, if applicable. It is a lot of work, so it’s important to consider your form of business from the start to avoid a headache. However, plans change, and so, too, can the type of entity.
Calloway Cook, president of U.S. ecommerce business Illuminate Labs, Inc., started as a C corp but is considering reincorporating in 2023 for increased tax efficiency. Here’s what Cook says:
“Most startups that plan to raise multiple rounds of funding incorporate as C corps. When I initially launched my business, I raised a small pre-seed investment round and planned to raise future funding. Our business is now profitable and I do not currently plan to pursue any future funding, so now the C corp status is inefficient because it makes payroll more costly compared to an LLC. I plan to consult both an accountant and a lawyer in 2023 and consider reincorporating my business to an LLC for increased tax efficiency specifically related to payroll tax.”
Last word on business entities
Entrepreneurs love to be in complete control of their new business, but what does that look like for you? Knowing the types of business entities in the U.S. will help you choose the right one so you can optimize your tax payments, limit your personal liability, and serve any partners, investors, and other players in a way that suits everyone best.
