Business structures influences accessibility to external funding, anyone that wants to invest or loan your money for your business would most likely ask for documents of your business structure to know how much they would invest or how much they can loan you.
What is Business Structure?
The legal structure of an organization recognized in a specific jurisdiction is referred to as its business structure. The legal form of a company determines what activities it can engage in, such as raising money, assuming responsibility for the company’s responsibilities, and the amount of taxes it owes to taxing authorities.
Types of Business Structure
The following are the business structures for a small business;
1. Sole Trader is also known as a Sole Proprietor
3. Private Company
Sole Trader/ Proprietor: This occurs when the company and the owners are the same. A sole trader has the advantage of being the simplest of business arrangements, requiring no registration as a legal body. Under the owner’s income tax, the taxes would be paid only once.
The drawback is that, because the firm and the owner are seen as one entity, any risks (such as being sued) would fall solely on the owner. As a result, if something goes wrong, the owner’s assets, such as his home and car, could be claimed.
Partnership: When a company has two or more owners but fewer than twenty, it is called a partnership. Because a partnership is not a legal entity, having a partnership agreement is critical. The earnings, losses, and other liabilities of the company are shared equally by all business partners. When it comes to taxes, each partner is accountable for paying their fair portion, as each partner gets taxed on their share of the earnings obtained.
Company (Limited Liability Company): The name of this company usually ends with (LTD), which stands for Limited, in several markets. Many firms begin as sole traders or partnerships and later convert to limited liability companies as their size or needs dictate.
Because the business is distinct from the owner, it must be registered as a separate legal entity with its own tax identification number.
Depending on your country’s laws, financial statements may need to be audited annually.
The cost of starting a business is higher, and managing it is slightly more difficult. Because the owner and the business are separate, the owner’s personal assets are largely shielded from the business.
How does your business structure impact your ability to source financing?
- Sole trader: A sole trader’s capacity to obtain funds is limited.
The quantity of money that can be accessed is likewise restricted by the amount of money that the owner can secure.
The credit risk is determined by the owner’s credit score.
As a result, if the owner has a poor credit history or a low credit score, it will have a direct impact on whether or not the company can obtain funding.
- Partnership: Because the financial capacity of all the partners is considered, a partnership has slightly less risk than a single trader.
To secure money, partnerships have the advantage of pooling their resources.
- Company: It is significantly easier to obtain finance for a corporation than it is for other business structures, especially when the company has been in operation for a longer period of time because banks will look at the company’s credit history to establish its creditworthiness.
Factors to consider before choosing a business structure
For new businesses that could fall into two or more of these categories, it’s not always easy to decide which structure to choose. You need to consider your startup’s financial needs, risk, and ability to grow. It can be difficult to switch your legal structure after you’ve registered your business, so give it careful analysis in the early stages of forming your business.
Here are some important factors to consider as you choose the legal structure for your business.
Flexibility: Where do you see your company going, and what kind of legal structure will allow it to expand the way you want it to? Review your goals in your business strategy and choose which structure best fits those aims. Your organization should foster the prospect of development and change rather than stifle it.
Complexity: Nothing beats a sole proprietorship when it comes to starting and operational complexity. You simply register your business name, begin doing business, record your profits, and pay personal income taxes on it. Outside funding, on the other hand, can be difficult to come by. Partnerships, on the other hand, necessitate a formal agreement that spells out the duties and profit splits. State governments and the federal government have different reporting obligations for corporations and limited liability companies.
Liability: Because it is its own legal entity, a corporation carries the least level of personal culpability. This means that creditors and consumers can sue the company, but they won’t be able to seize the officials’ or shareholders’ personal assets. An LLC provides the same level of protection as a sole proprietorship while also providing tax benefits. Partnerships divide liabilities among the partners according to the terms of their partnership agreement.
Taxes: As a small business owner, you want to avoid double taxation in the early stages. The LLC structure prevents that and ensures you’re treated as an individual, not a company.
Individuals who are part of a partnership can claim their share of the profits as personal income as well. To minimize the end effect on your return, your accountant may recommend quarterly or biannual advance payments.
Each year, a corporation files its own tax returns, paying taxes on profits after deducting expenses such as wages. If you pay yourself from the corporation, you will pay personal taxes, such as for Social Security and Medicare, on your personal return.
Control: A sole proprietorship or an LLC may be the best option for you if you want sole or principal control over your business and its activities. Control can also be negotiated in a cooperation agreement.
A corporation is designed to have a board of directors that makes the company’s important decisions. A single individual can oversee a corporation, especially at its birth, but as it grows, the requirement for it to be run by a board of directors grows as well. The regulations designed for larger companies – such as keeping track of every key action that affects the company – nevertheless apply to small businesses.
Tip: Before assuming obligation, think about the tax structure and industry regulations. You can choose the best business structure for you by generating a list of particular characteristics of your company and its founders.
Capital investment: If you need outside finance, such as from an investor, venture capitalist, or bank, forming a corporation may be a preferable option. Corporations are more likely than sole proprietorships to be able to seek outside finance.
Corporations can sell stock to raise money for expansion, but sole proprietors can only get money from their personal bank accounts, personal credit, or by bringing in partners. An LLC can suffer comparable challenges, albeit because it is its own business, the owner does not always need to use their own credit or assets.
Licenses, permits, and regulations: You may require particular licenses and permits to operate in addition to officially registering your business entity. Depending on the sort of business and its activity, local, state, and federal licenses may be required.
Varying states have different regulations for different types of businesses. There may be varying criteria at the municipal level depending on where you start your shop. Understand the state and industry you’re in as you choose your structure. It isn’t a ‘one-size-fits-all’ solution, and firms may be unaware of what is relevant to them.
Only for-profit businesses are covered by the structures outlined here. If you’ve done your homework and still aren’t sure which business structure is best for you.