Business Types: How to Choose a Business Structure

When starting a business, one of the first major decisions you will make is choosing a business structure. The type of business structure you choose can impact many aspects of your business, such as daily operations, taxes, and your personal liability risk. To select the best structure for your small business, you want to consider a few essential factors such as upfront and on-going costs, if you will need liability protection, if you will seek outside investment and tax implications.

Table of Contents:

• Types of Business Structures
• Formal Business Structures
• Informal Business Structures

Types of Business Structures

There are four basic types of business structures: Sole Proprietorship, Partnership, Limited Liability Company (LLC), and Corporation. These structures fall into two categories at the most basic level: Formal and Informal Business Structures.

• Formal Business Structures:
  LLCs and Corporations are formal structures with some up-front and ongoing costs and require state-level registration to start. Being formed formally with the state, businesses operating under these structures are separate entities from their owners.


• Informal Business Structures:
  Sole Proprietorships and Partnerships are informal structures. They require minimal or no registration requirements to start. As informal structures, these types of businesses have no separation between the owners and business. As a result of this difference, informal business structures are open to more risk as they lack personal liability protection.

Formal Business Structures

Formal business structures require a state-level filing to be legally formed. Formal business structures are distinct entities from their business owners. As a result, they offer limited liability protection for owners, meaning that their personal assets are protected. Formal structures offer various taxation options and benefits, which make them a go-to choice for many small business owners. The two main formal business structures are Limited Liability Company (LLC) and Corporation.

Formal Structures Table of Contents:

• Limited Liability Company (LLC)
• Corporation
• Who are Formal Structures for?
• Advantages of Formal Business Structures
• Disadvantages of Formal Business Structures
• LLC vs Corporation: How to Choose

Who are Formal Structures for?

Formal business structures like LLCs and Corporations are good options for businesses that:

• Have potential or plan to be immediately profitable
• Are at increased liability or loss risk
• Will have a more extensive customer base
• Want more financing and investment opportunity
• Desire flexible taxation options

Advantages of Formal Business Structures

LLCs and Corporations offer three main advantages compared to informal business structures:

• Limited Liability Protection:
  Have peace of mind knowing that your personal assets like your car, home, and personal bank account won’t be at risk if your business accrues debt or faces a lawsuit.


• Increased Access to Financing and Investment Opportunities:
  Forming your businesses as a formal structure increases the likelihood of receiving financing to start and grow your business. Having a formal business structure makes it much easier to allow outside investors to fund your business.


• Taxation Flexibility and Benefits
  LLCs and Corporations have unique tax benefits that can suit a broader range of businesses. They also provide flexibility to elect different taxation classifications such as S Corporation taxation, which can offer tax savings.

Disadvantages of Formal Business Structures

LLCs and Corporations have two primary disadvantages compared to informal structures like Sole Proprietorships and Partnerships:

• Up Front Cost:
  When using a formal structure, you will need to pay a filing fee to the state and an on-going fee each year. Since you’ll only need to pay for business licenses and permits to get started, the out-of-pocket costs for creating an informal business will be lower.


• Time to Setup and On-Going Maintenance:
  When setting up a formal business, you’ll need to file formation documents to be legally registered. In addition to this, you’ll need to complete a brief filing each year to maintain good standing with your state.

LLC vs Corporation: How to Choose

When choosing between an LLC and a Corporation, more small businesses choose and benefit the most from forming as an LLC. Most small businesses choose an LLC due to the pass-through taxation it provides compared to the double taxation that a Corporation experiences.

More small business owners choose to form an LLC. Both provide limited liability protection, but an LLC allows its owner(s) to pay a lower overall tax rate. This is because LLCs are pass-through entities by default. In contrast, Corporations are subject to “double-taxation” by default at the federal level.

While most small businesses choose to start as an LLC, you may want to consider forming as a Corporation if you plan on seeking significant outside investment or angel funding. A Corporation allows investors to avoid excessive taxation by only taxing distributed profits. Since an LLC’s investors would be required to pay taxes on all profits, whether they were distributed or not, investors almost exclusively work with Corporations.

Informal Business Structures

Informal business structures operate without formal recognition of being separate legal entities from their owners. Sole Proprietorships and Partnerships are the most common types of informal businesses. Informal businesses generally require little to no formal registration. Suppose you begin conducting business activities without creating a separate legal entity like an LLC or Corporation. In that case, you are a sole proprietor (1 owner) or a partnership (2 or more owners). While this can make getting started with your business quicker and easier, it does have downsides such as being much harder to get loans and credit as well as having unlimited liability risk for business debts or lawsuits.

Informal Structures Table of Contents:

• Sole Proprietorship
• Partnership
• Who are Informal Business Structures for
• Advantages of Informal Business Structures
• Disadvantages of Informal Business Structures

Who are Informal Business Structures for

Informal business structures like Sole Proprietorships and Partnerships are suitable structures for:

• Businesses that have minimal risk
• Don’t plan on needing outside investment or funding
• Testing a business idea before committing to a formal structure
• Are very small or are hobbies

Advantages of Informal Business Structures

Informal business types have a few advantages when compared to forming an LLC or Corporation:

• Lower Upfront Cost:
  Sole Proprietors and Partnerships require no formal registration thus are only required to obtain relevant business licenses and permits.


• Quicker to Get Started:
  With a lack of any legal paperwork or registration, you can get started as soon as your business is properly licensed.

Disadvantages of Informal Business Structures

Establishing a business that uses an informal structure is simple. However, it has some significant disadvantages that you will want to consider, such as:

• Unlimited Personal Liability:
  Your personal assets like your home, vehicle, and personal bank account could be at risk if your business is sued or has debts.


• Limited Potential for Growth
  It is much harder to get financing and investment to grow your business.


• Not as credible and brandable
  You must operate under your personal name(s), making it harder to create a credible brand

Business Structure Frequently Asked Questions (FAQs)