Business Structure

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Blog Author :

WallStreetMojo Team

Edited by :

Ashish Kumar Srivastav

Reviewed by :

Dheeraj Vaidya, CFA, FRM

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What is a Business Structure?

A business structure refers to how a company wants to represent itself legally in the industry on formation. It is the type of setup that allows and restricts activities a business undertakes as an entity after its establishment.

What Is A Business Structure

Deciding on a structure is the foremost thing people need to do when they want to set up a business entity. Multiple factors need consideration before a legal business structure is decided. A few include the type or nature of business, complexity involved, the investment required, liability assumed, tax incentives, and other legal formalities. 

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How Does A Business Structure Work?

A business structure recognizes an entity as a legal business setup in the market. So the first thing people have to do is decide on what kind of structure they need. The structure's choice depends on how they want their company to be represented, how they want it to operate and by how many people, the taxes that will apply once the setup is ready, and the investments and liabilities involved.

Based on all the factors, the aspiring business people decide their business structure and plan their further activities in accordance with the same. The formalities related to business registration, license, and legal regulations – all depend on the type of business structure one chooses.

Depdending on the structure, the roles and responsibilities of the people holding different positions in the organization are assigned. Plus, the number of capitals to be raised, the investments required, the taxes that apply, and multiple other determinants are accounted for in selecting the structure for the organizations to keep their processes simple, transparent, smooth, and convenient for members.

Types of Business Structure

Business structures are classified into five categories:

#1 - Sole Proprietorship

A structure is termed sole proprietorship when a person is the sole owner of a business. It is a simple setup where the owner is the single person responsible for the daily business operations. Here the business is not treated as a separate entity. Thus, the revenues and liabilities are merged into their personal accounts, which are calculated and taxed on a personal level.

The owner must fill out Form 1040 with Schedule C and SE for the self-employment tax to apply.

#2 - Partnership

When two or more people own a business entity, it is referred to as a partnership venture. These are similar to sole proprietorship as the entity does not have a separate legal recognition in the market. Instead, the enterprise and the owners are considered as single entities.

This is a business structure where each owner actively participates in the daily business operations. They take all decisions about growth and expansion collectively, often governed by an operating agreement, especially in multi-member LLCs. Plus, the revenues and liabilities are shared equally among all the partners.

While filing taxes, each partner must fill up Form 1065 and draft reports per their share of profits and losses in the business. This way, the taxes and returns are filed along with their respective individual tax returns.

Business Structure Types

#3 - Corporations

This business structure recognizes owners and entities as two separate units. It is a complex form, but large firms prefer registering as corporations. When creditors claim outstanding dues, they do not include owners as individuals. Instead, they claim to the business as a whole.

A corporation can issue both common and preferred shares. If a shareholder dies, they can transfer the shares to others. These are expensive setups being listed in exchanges, and thus, they involve legal formalities in forming the board and setting up other venture-related units.

Double taxation is a drawback. When owners and businesses become separate legal entities, the tax applies to the business and the individual owners separately. The corporate tax is levied on the business firm separately. When the shareholders receive dividends, a dividend tax is also applied on a personal level, affecting the owners' personal income.

#4 - S-Corporations

The business structure protects the liabilities of a corporation and helps enjoy tax benefits. Hence, small businesses prefer these options more. However, for a business to become an S-Corp, it has to fulfill certain criteria specified by the Internal Revenue Service (IRS). 

If an entity registers as an S-Corp, it is restricted to having not more than 100 shareholders, who must be citizens of the United States. The revenue and liabilities are distributed among shareholders according to their share of investments, and tax returns are computed individually. In short, no double taxation applies here.

Unlike other corporations, the S-Corp is allowed to issue one particular class of stock, which restricts its capital raising capacity.

#5 - Limited Liability Company (LLC)

An LLC is a type of structure that merges features of both partnerships and corporations. The revenues and losses are distributed to shareholders equally per their share of investment. Thus, the single level of taxation applies here.

There is no restriction on who can become a member of the LLC. Most states allow individuals, corporations, and even foreign entities to become a part of it. In some states, there might be a single-member LLC with one owner controlling the entire venture.

Examples

Let us consider the following business structure example for a better understanding of the concept:

Scenario #1

Scarlet worked and saved money for 10 years while working on establishing her own venture. She wanted to start as a sole owner before finally thinking about other forms of structure. Hence, she opted to try it with a sole proprietorship and be the sole controller of her business. She established it at inexpensive rates as it involved minimal charges and was quite simple to pull off. Plus, she knew she wouldn't be answerable to anyone as there would be complete privacy and no public disclosure of annual reports.

Scenario #2

As her venture did well, she issued shares and got listed on the stock exchange. With the number of investors, the number of venture owners increased, and she managed to move from sole proprietorship to partnership and co-owning a large firm, i.e., a corporation.

Factors to Consider

Owners should consider some important parameters before they decide on their business structure. First, they must be clear about the type and nature of their business and choose the structure accordingly. Having a synchronized structure per the nature of the business helps in the smooth running of the business, and daily operations are better carried out.

Business Structure - Factors to Consider

The complexities involved need consideration. The regulations, formalities, and licenses involve a lot of complications. Hence, businesses explore the complications involved and decide which structure they would opt for. Plus, the owners must know the way liabilities and revenues are distributed. Then, the taxation part is important. Each structure offers important considerations from understanding single federal taxation or double taxation to knowing the tax benefits.

Frequently Asked Questions (FAQs)

What is a business organizational structure?

Business Structure refers to the type of setup an investor wants to put in before starting a business. It primarily depends on the type of business, liability assumed, and tax incentives. Some types of these structures are Sole proprietorship, partnership, corporations, S-corporation, and Limited Liability Company (LLC).

How to choose a business structure?

When choosing a business structure, one must check the number of owners their venture will have. Then, the type of taxation they would be open to, the structure that best suits their daily business operation, the control they want to have, the level of credibility, liability, borrowing ability, etc., should be determined.

Can you change your business structure?

The legal structure of a business cannot stick to one type. As businesses grow and evolve, the requirements change, and they adapt to the changes around them. In accordance with that, the owners can consider changing the business structure.