Cooperative
A cooperative (co-op) is owned by the same people it serves. Its offerings benefit the company’s members, also called user-owners, who vote on the organization’s mission and direction and share profits.
Cooperatives offer a couple main advantages.
- Increased funding: Cooperatives may be eligible for federal grants to help them get started.
- Discounts and better service: Cooperatives can leverage their business size, thus obtaining discounts on products and services for their members.
Forming a cooperative is complex and requires you to choose a business name that indicates whether the co-op is a corporation (e.g., Inc. or Ltd.). The filing fee associated with a co-op agreement varies by state.
Key takeaway: The five types of business structures are sole proprietorship, partnership, limited liability company, corporation and cooperative. The right structure depends mainly on your business type.
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. Consider your startup’s financial needs, risk and ability to grow. It can be challenging to switch your legal structure after registering your business, so give it careful analysis in the early stages of forming your business.
Here are some crucial factors to consider as you choose your business’s legal structure. You should also consult a CPA for advice.
Flexibility
Where is your company headed, and which type of legal structure allows for the growth you envision? Turn to your business plan to review your goals and see which structure best aligns with those objectives. Your entity should support the possibility for growth and change, not hold it back from its potential. [Learn how to write a business plan with this template.]
Complexity
When it comes to startup and operational complexity, nothing is more straightforward than a sole proprietorship. Register your name, start doing business, report the profits and pay taxes on it as personal income. However, it can be difficult to procure outside funding. Partnerships, on the other hand, require a signed agreement to define the roles and percentages of profits. Corporations and LLCs have various reporting requirements with state governments and the federal government.
Liability
A corporation carries the least amount of personal liability since the law holds that it is its own entity. This means creditors and customers can sue the corporation, but they can’t gain access to any personal assets of the officers or shareholders. An LLC offers the same protection but with the tax benefits of a sole proprietorship. Partnerships share the liability between the partners as defined by their partnership agreement.
Taxes
An owner of an LLC pays taxes just as a sole proprietor does: All profit is considered personal income and taxed accordingly at the end of the year.
“As a small business owner, you want to avoid double taxation in the early stages,” said Jennifer Friedman, principal at Rivetr. “The LLC structure prevents that and makes sure you’re not taxed as a company, but as an individual.”
Individuals in a partnership also claim their share of the profits as personal income. Your accountant may suggest quarterly or biannual advance payments to minimize the effect on your return.
A corporation files its own tax returns each year, paying taxes on profits after expenses, including payroll. If you pay yourself from the corporation, you will pay personal taxes, such as those for Social Security and Medicare, on your personal return.
Tip: To simplify payroll complexities and taxation issues, consider using a payroll service. Check out our reviews of the best payroll services to find a partner that fits your needs and budget.
Control
If you need to obtain outside funding from an investor, venture capitalist or bank, you may be better off establishing a corporation. Corporations have an easier time obtaining outside funding than sole proprietorships.
Corporations can sell shares of stock and secure additional funding for growth, while sole proprietors can obtain funds only through their personal accounts, using their personal credit or taking on partners. An LLC can face similar struggles, although, as its own entity, it’s not always necessary for the owner to use their personal credit or assets.
Licenses, permits and regulations
In addition to legally registering your business entity, you may need specific licenses and permits to operate. Depending on the type of business and its activities, it may need to be licensed at the local, state and federal levels.
“States have different requirements for different business structures,” Friedman said. “Depending on where you set up, there could be different requirements at the municipal level as well. As you choose your structure, understand the state and industry you’re in. It’s not ‘one size fits all,’ and businesses may not be aware of what’s applicable to them.”
The structures discussed here apply only to for-profit businesses. If you’ve done your research and you’re still unsure which business structure is right for you, Friedman advises speaking with a specialist in business law.