What Is the Meaning of Business Organization?

You’ve decided to do what many Americans only dream of: launch a business. It’s an epic hurdle, but now you face another big decision: how you will legally structure your business organization.

This decision carries far-reaching implications, especially in terms of how much you will pay in taxes and how much of your personal assets will be at risk should you be sued. The five most common organizational types for a small business are a sole proprietorship, partnership, C-corporation, S-corporation and limited liability company. The draws and drawbacks of each type should lead you to choose the right organizational structure for you.

Consider a Sole Proprietorship

Just as its name implies, a sole proprietorship is owned by one person, who assumes all the assets of the business as well as all the debts. In the eyes of the law, there is no “line” between the business and the owner; they are one and the same.

Draw: This type of business organization – so simple to form and dissolve – may appeal to people with low-risk businesses or those who wish to do a “test run” before before committing to a more formal structure.

Drawback: A high-risk venture, or one that requires a large amount of start-up debt, would put the sole proprietor’s personal assets at risk, too.

Consider a Partnership

Partnerships bring two or more owners together, usually in the form of a general partnership – which splits profits, management and liability – or a limited partnership or a limited liability partnership. A common choice of doctors and lawyers, an LLP insulates each partner’s assets. Forward-thinking partners draft a legal agreement that spells out who will make decisions, how disputes will be reconciled, how (or if) future partners will be added to the business and how partners can be bought out.

Draw: Partners who realize they have different strengths can flourish in a partnership when they build a business to play to those strengths.

Drawback: Partners who do not share the same values, purpose and mission can quickly find themselves at odds – and their partnership at risk of imploding.

Consider a Corporation

A corporation, also known as a C-corp, is legally considered a separate entity from the people who own it. A C-corp can make contractual agreements, and it can also be taxed and sued. The owners are known as shareholders, who elect a board of directors to formulate policy and make business decisions. Sometimes, C-corp profits are taxed twice: when the company turns a profit and then again when shareholders are paid dividends.

An S-corporation, also known as an S-corp, is designed to avoid this pitfall. S-corps are known as “pass-through” entities because their profits, losses, credits and deductions literally pass through the corporation and go to the company’s shareholders. They square the numbers on their personal income tax returns, thereby avoiding double taxation. This feature helps explain why S-corps are the most favored form of business organization among business owners.

Draw: If you want the highest level of protection for your personal assets, a corporation will provide it.

Drawback: Corporations require thorough record-keeping, operational processes and reporting.

Consider a Limited Liability Company

Think of an LLC as a hybrid of a corporation and a partnership. It can shield the personal assets of the owners, who are known as “members.” This shield covers savings, investments, property and vehicles in case of a lawsuit or bankruptcy filing. And profits and losses do not face corporate taxes.

Draw: LLCs provide superior protection as long as a business is run ethically and the members are judicious about keeping their personal and business finances separate. After S-corps, LLCs are the second-favorite choice among entrepreneurs.

Drawbacks: Members of an LLC are considered self-employed. As such, they must make contributions toward Social Security and Medicare. Also, this business structure does not always provide an iron-clad level of personal protection: an LLC owner found guilty of illegal or fraudulent conduct could still be held personally liable in a lawsuit.

Be certain to investigate the details, requirements, caveats and exclusions before you commit to one type of business organization – or even order business stationery. Consult your lawyer and accountant for their best advice, too. Since they’re no doubt aware that you’ve embarked on an epic journey, they’re probably waiting for your phone call.