Starting a new business is a massive endeavour involving many complex decisions, but choosing an ownership structure for your company will be one of the earliest and most important ones that you will have to make.
This is a step that should not be taken lightly; the choice you make here will define the crucial early years of your business. Indeed, the form of business ownership you select will define your company's legal structure, tax obligations and compliance requirements, as well as the level of risk it will expose your personal finances and assets to.
Before we take a close look at the different types of business ownership, though, let's first consider the factors mentioned above and how they can impact your choice.
Factors to Consider When Selecting an Ownership Structure
When making such a decision, the most crucial factor to consider is the nature of your business, or, to be more precise, the level of risk involved. If it is a highly competitive field, such as hospitality, for instance, it raises the potential risk to your personal finances. Therefore, in this particular situation, you may want to consider a form of ownership that minimises your personal liability.
Another key consideration is the quantum of resources and finances at your disposal. Some forms of ownership come saddled with strict compliance requirements, and you may not have the resources or know-how to handle all the bureaucratic hoops you will have to jump through to get your new firm up and running.
Larger, more complex forms of ownership require a group of entrepreneurs to flourish and, if you have the contacts and networks, this can be quite easy. If you are starting on your own (or with a friend or relative), however, practical options may be somewhat limited as far as business ownership is concerned.
You also need to consider what your plans and aspirations are for your enterprise. Do you plan to hold its reins tightly in your own hands indefinitely, or do you want to expand and bring in more investors? Maybe you have a dream of going for an IPO with your business? These considerations should also be taken into account when deciding the form of business ownership.
Once you have seriously thought about these fundamental points, you can then begin to make a decision. There are four major types of business entities based on ownership: let's take a look at all four, and identify their main features.
Going purely by numbers (not size), the vast majority of businesses in the world today are small and medium enterprises. A sole proprietorship is one of the most popular forms of ownership for companies such as these.
Arguably, the popularity of sole proprietorship stems from its incredible simplicity - setting one up is a breeze when compared to some of the more complex forms of business organisations. All you need are the necessary licenses and permits (depending on your business sector), and the requisite funds, with minimal paperwork required.
If you want to be your own boss, then this is the ideal place to start, since you are in total control. You don't have to worry about internal politics or conflicts as you are the sole owner. Taxation is also minimal, as you only have to file it once, instead of twice as is required in companies.
However, the single biggest weakness of this structure is, by far, the level of personal liability involved. Since there is no legal distinction between the business and your finances, your personal assets will end up in jeopardy if the business struggles.
While independence is good, it also means that you don't have anybody to help you make crucial decisions. If you mess up, your business could quickly go belly up.
Partnerships are also a very common form of ownership in the SME segment of the market. If you have two or more people interested in starting a business enterprise together, then a partnership is the simplest option.
Although the paperwork and tax liabilities are more complex than in the case of a sole proprietorship, you do have other people to assist you. This is one of the main strengths of this form of organisation - you are not on your own. A partnership is not restricted to individuals, either; it can be between two or more organisations, or even between multiple organisations and individuals.
They can also be quite flexible. If you want to share responsibilities and powers equally, opt for a general partnership. If you want others to put up the money (for a share in profits) while you control the business, go for a limited partnership.
With more owners, your personal liability in the business is also reduced. The volume of resources available to you could also be higher for obvious reasons, while you don't have to worry about double taxation either.
Unfortunately, their disadvantages also stem from the source of this strength - having more people can be a liability when conflict inevitably rears its head. Plus, if any partner makes a mistake, everyone else can end up paying the price.
The biggest and most influential companies in the world are mostly corporations. They have many advantages and are considered the most flexible and resilient forms of business organisations. There are many different forms of corporations, too, such as C Corporations, S Corporations, B Corporations, and Non-profits.
A corporation is considered a separate legal entity, with its own rights, liabilities, and obligations. As an owner, you will only have limited liability in a corporation, which means that even if the business gets sued, your personal assets will escape unscathed.
Setting up a corporation is no easy task, though. You are required to satisfy numerous conditions, such as appointing a board of directors, maintaining and publishing numerous records, and complying with a whole array of complex regulations. They are also quite expensive to set up.
Your ownership in a corporation is not absolute, either - it can get diluted through the sale of stocks, while the actions you take in your official capacity at the corporation can be held accountable by the board and other shareholders.
Taxation is also an issue, as you can be taxed twice - once as business revenue, and then again on your personal income.
Limited Liability Company (LLC)
To put it one way, an LLC is a hybrid between a partnership and a corporation that tries to combine the best of both worlds. Essentially, your business functions like a partnership, but with the limited liability of a corporation.
If you can provide enough paperwork, you can also avoid getting taxed like a corporation. Like partnerships, you can involve individuals, businesses, trusts and corporations, as well as other LLCs.
While they do possess many strengths and benefits, they are not very easy to set up, though. To unlock their full potential, you have to satisfy a lot of bureaucratic conditions, while you also leave yourself open to scrutiny from governmental agencies.
- If you are a first-time entrepreneur, alone and with limited funds, a sole proprietorship is probably the best form of business ownership for you.
- If it is a high-risk venture, though, you might want to try bringing more people on board to start a partnership.
- If you have more resources, contacts, partner individuals and firms, a corporation is one of the best options for the long term growth and stability of your business.
- For something with a bit more control, less compliance and tax requirements than a full-fledged corporation, an LLC is the ideal choice.
Which type of business ownership do you think is best? Let us know your thoughts in the comment section below.