In the commercial field, a business structure refers to the organization of a company in regards to its legal status. Choosing the most appropriate business structure creates a legal recognition for your trade. Above all, a business structure trickles down to so many other factors which are part and parcel of running a successful business.
For instance, it gives you the best approach to deal with all tax liabilities. That aside, you get to apprehend all your duties and responsibilities as a business owner. A business structure enlightens you more about all the legal documentation you need. Certainly, this will depend on the jurisdiction where your establishment will be located.
What's more imperative, is the fact that it shows all possible personal liabilities that a business owner or partner might incur. Most importantly, you ought to put into consideration, all the setup costs which include insurance policies to protect the business' assets. There are a couple of structures which are commonly used to incorporate a business.
So let's have a look.
Primarily, it's the simplest of all to set up. It explains why it's the most popular business structure across so many setups. As the name suggests, it means that an individual business owner gets to operate the establishment on their own. Aside from that, it requires less effort when doing the reports and the business owner has the power to make all financial decisions which relate to operating the business.
As a sole trader, you're at free will to file all tax returns using your personal tax filing information. The best part about a sole proprietorship is that it's not a legal entity. What does this mean? The business name isn't separate from the owner. This implies that you can operate a business using your own name, as in, Jimmy's Barber Shop. In other words, there are no legal restrictions set.
On the flipside, a sole proprietor is personally liable for all the debts and liabilities which the business might incur the course of running its operations. If the business default's to pay the debts it owes, this means that the creditors can file a bankruptcy petition against the business owner. One more set back is that the sole proprietor can't sell shares to raise starting capital for the business.
A partnership is created where a legal agreement is put in place to allow two or more individuals to carry out a specific business as co-owners in a bid to make a profit. In such a structure, all members contribute capital to set up the business. Typically, there are two major forms of partnerships. There's a general partnership where the members actively participate in the daily operations of the business. On the other hand, we have a limited partnership which has the capacity to have up to 20 members.
In a limited partnership, the general partner is responsible for the daily activities in the business and is personally liable for all debts. The passive partners in this scenario, are only required to contribute a certain amount of capital to the business but aren't liable of any debts incurred. That is to say, they have limited liability.
It's worth noting that a partnership enjoys the pass-through status. In actual sense, it means that all profits and liabilities pass through to the owners. There may be equity partners and salaried partners in the business where some partners are just mere employees while others have a share in the partnership.
While forming a partnership, it's mandatory to follow all the legal requirements in your state. A partnership agreement needs to be part of the equation so as to capture each partner's financial contribution and their responsibility in the partnership. It significantly lays out the mediation procedure in the event of a dispute in the future. Also, it captures the process to be followed when the members decide to dissolve the partnership.
Take note that personal liability is limited for each member in the ratio at which one contributed to the setup of the business.
So what are the benefits of forming a partnership?
- They're easy to set up
- No complex reporting is involved
- Dissolving a partnership is simple. A partner can opt out and reclaim their share.
- All tax losses are split among the business partners
Limited Liability Company (LLC)
This is a legally registered business structure which is limited by shares. All shareholders in such a structure are liable for all the liabilities the company incurs however, it's limited to the number of shares which an individual contributes to the company. First, you need to come up with a business name which denotes the kind of operations the setup engages in. It should end with the descriptor ‘LLC'.
What follows is filing the Articles of Organization. This document is similar to the Articles of Association which regulates the appointment of company directors and issuance of shares. The Articles of Organization records all the important information which relates to the LLC. This includes its physical address, the official name of the LLC, and all details of the filing agency. Besides that, it records the date which the company intends to kick off its operations.
Just like a Partnership, an LLC needs an Operating Agreement. Simply put, it sets out all the rights and obligations of each partner in the LLC. It records the amount contributed by each member and the percentage at which the proceeds will be split. All tax considerations are also part of the contents in this document. Talking of taxes, a tax registration certificate needs to be obtained from the relevant authorities.
An LLC is an exceptional business structure since it doesnt follow all the formal requirements like those of a Corporation. The members unanimously agree on how the business should be run. They don't necessarily need a board of directors. It's compatible with small and medium-sized businesses. They don't need to keep sophisticated documentation or hold meetings to discuss matters related to the business.
This kind of business structure is a bit sophisticated. It's a separate legal entity which means it's a juridical body responsible for its own debts and liabilities. It has the capacity to enter into a contract under its own name, borrow money from creditors, sue or be sued, and own assets.
A private corporation can issue an Initial Public Offer(IPO) as a means to raise capital. The shareholders will then gain profits in the form of dividends within a stipulated period of time. To gain familiarity, we have corporations such as eBay, Apple, Google or PayPal, just to name a few which sell stocks to the public. From this point, any potential investor gets a market share of the corporation's assets and profits.
So here's how a corporation is run.
This business structure is incorporated by a bunch of shareholders whose goal is to gain profit. Their sole responsibility is to pay for the subscribed shares. Consequently, a corporation can only have one shareholder or a couple of them. If a corporation goes public, it can have as many shareholders as possible.
In contrast to LLCs and partnerships, a corporation personally handles all the tax obligations. Each shareholder gets one vote per share to elect the board of directors. The board of directors is mandated to deal with the daily operations in the corporation. They hold meetings to deliberate on how best the business strategies will be achieved.
A corporation can be brought to an end either via liquidation or winding up. The liquidation process can be initiated either voluntarily or involuntarily. It can be involuntary where the creditors want to recover all the debts which the corporation owes them. Corporations are suitable for high-end investments which need huge amounts of start-up capital. Hence, it's capacity to raise money through the issuance of shares.