How to Choose the Right Business Structure for Your Startup in USA

Starting a new business can be an exciting venture, but it also means making some critical decisions that can hugely affect success. The most important decisions a founder will make have to do with the right structure for his or her startup. This would majorly impact your legal liability and tax liability, aside from raising the ability to raise capital. In this post, we’ll cover the many variations of business structures available in the United States, and discuss which ones are best for founders located both inside and outside the USA.

Understanding Business Structures in the United States

The United States offers several types of business structures, each with its own advantages and disadvantages. The main types are:

1. Sole Proprietorship
2. Partnership
3. Limited Liability Company (LLC)
4. Corporation (C-Corp and S-Corp)
5. Nonprofit Organization

Let’s delve into each of these structures to understand their key features and how they might suit your needs as a founder.

Sole Proprietorship

A sole proprietorship is the simplest and most common form of business structure. It is an unincorporated business owned and operated by one individual.

Advantages:

• Easy and inexpensive to establish.
• Complete control over business decisions.
• Profits are reported on the owner’s personal income tax return.

Disadvantages:

• Unlimited personal liability for business debts and obligations.
• Difficulty in raising capital.
• Limited growth potential.

Best For:

• Founders looking for a simple business setup.
• Individuals who want full control over their business operations.

Partnership

A partnership involves two or more people who agree to share the profits and losses of a business. There are two main types of partnerships: General Partnerships (GP) and Limited Partnerships (LP).

Advantages:

• Easy to establish with shared responsibilities.
• Combined resources and expertise.
• Profits taxed as personal income of the partners.

Disadvantages:

• Unlimited personal liability for general partners.
• Potential for conflicts between partners.
• Limited partners have no management authority in LPs.

Best For:

• Founders who want to collaborate with others and share management responsibilities.
• Those who need additional capital and expertise.

Limited Liability Company (LLC)

An LLC is a hybrid structure that combines the benefits of a corporation and a partnership or sole proprietorship. It offers limited liability protection to its owners (called members).

Advantages:

• Limited liability protection for members.
• Flexibility in management and profit distribution.
• Pass-through taxation (profits taxed on members’ personal returns).

Disadvantages:

• More complex and costly to establish than sole proprietorships or partnerships.
• Varying state regulations.
• Self-employment taxes on profits.

Best For:

• Founders who want liability protection without the complexities of a corporation.
• Businesses planning to have multiple owners or investors.

Corporation

Corporations are separate legal entities owned by shareholders. There are two main types: C-Corporations (C-Corps) and S-Corporations (S-Corps).

C-Corporation (C-Corp)

Advantages:

• Limited liability for shareholders.
• Ability to raise capital through stock issuance.
• Perpetual existence.

Disadvantages:

• Double taxation (profits taxed at the corporate level and again as shareholder dividends).
• Complex and costly to establish and maintain.
• Extensive record-keeping and regulatory requirements.

Best For:

• Founders planning to raise significant capital.
• Businesses intending to go public or offer stock options.

S-Corporation (S-Corp)

Advantages:

• Limited liability for shareholders.
• Pass-through taxation (profits taxed on shareholders’ personal returns).
• Avoids double taxation.

Disadvantages:

• Limited to 100 shareholders.
• Shareholders must be U.S. citizens or residents.
• Stricter operational processes.

Best For:

• Founders wanting the benefits of a corporation without double taxation.
• Smaller businesses with U.S.-based owners.

Nonprofit Organization

Nonprofits are established for charitable, educational, religious, or similar purposes. They are exempt from federal income taxes.

Advantages:

• Tax-exempt status.
• Eligibility for grants and donations.
• Limited liability for directors and officers.

Disadvantages:

• Strict compliance with regulations.
• Prohibited from distributing profits to members.
• Extensive record-keeping and reporting requirements.

Best For:

• Founders with a mission-driven purpose.
• Organizations seeking to provide public or community benefits.

What is the Difference Between LLC and Sole Proprietorship?

One of the common dilemmas that a new founder faces is how to choose between an LLC and a sole proprietorship. The following are key differences:

Liability Protection

• LLC: There is limited liability protection, meaning personal assets are safe from business debts and lawsuits.
• Sole Proprietorship: No liability protection is offered, that is, business creditors have access to personal assets to meet business debt and other obligations.

Taxation

• LLC: The profits are normally pass-through, and thus reported on the members’ personal tax returns. The LLCs may also elect to be treated for taxation purposes as a corporation.
• Sole Proprietorship: The profits are reported on the owner’s personal tax return, so there is just one layer of taxation.

Management and Control

• LLC: It may have any number of members, and the management structure may be designed according to need. Members may manage or appoint managers.
• Sole Proprietorship: It is solely managed by the owner, providing the business owner with full control over every business decision.

Cost and Complexity

• LLC: LLCs are more complex and expensive to establish and maintain. To become an LLC, owners must file articles of organization, draft an operating agreement, and then maintain compliance with the state.
• Sole Proprietorship: A sole proprietorship is easier and less expensive to set up. Typically, it requires minimum paperwork or regulatory compliance.

Raising Capital

• LLC: An LLC can generate capital by admitting new members or selling interests in the ownership.
• Sole Proprietorship: The capability of a sole proprietorship to raise capital is limited. It normally relies on personal savings or loans.

+----------------------+--------------------------------------------+-----------------------------------+
|                      |                    LLC                     |        Sole Proprietorship        |
+----------------------+--------------------------------------------+-----------------------------------+
| Liability Protection | Limited liability protection               | No liability protection           |
| Taxation             | Pass-through or corporate taxation options | Personal income tax               |
| Management           | Flexible (members or managers)             | Sole owner                        |
| Cost and Complexity  | Higher setup and maintenance costs         | Lower setup and maintenance costs |
| Raising Capital      | Easier to raise capital                    | Limited ability to raise capital  |
+----------------------+--------------------------------------------+-----------------------------------+

Choosing the Right Structure for Founders in the USA and Abroad

Founders Located in the USA

The choice for founders located within the United States largely depends on the size and the goals of the business.

• Small Businesses: A sole proprietorship or partnership is ideal for small businesses that involve low risk and where the founders want simplicity with personal control.
• Growing Startups: An LLC offers flexibility and protection and is best suited for growing startups eyeing investors in their future road map.
• High-Growth Companies: Because VCs only invest in C-Corps, this business structure is needed for any business that has plans for venture capital funding or that may want to go public one day.

Founders Located Outside the USA

In the case of international founders, business structure may be driven by tax treaties, ease of management, liability concerns, and so on. For example:

• LLCs: It’s a very compelling idea for an LLC for international founders who want to avoid double taxation, seeing that it holds a fine balance between liability protection and flexibility.
• C-Corps: This is good for founders who would want massive investment from U.S. venture capitalists or, at some point in time, go public.
• S-Corps: This is generally not applicable to non-U.S. residents because of shareholder restrictions.

+---------------------+-----------------------------+---------------------+------------+-----------------------------------------+
|      Structure      |    Liability Protection     |      Taxation       | Complexity |                Best For                 |
+---------------------+-----------------------------+---------------------+------------+-----------------------------------------+
| Sole Proprietorship | None                        | Personal income tax | Low        | Small, low-risk businesses              |
| Partnership         | General partners: unlimited | Personal income tax | Low        | Collaborative ventures                  |
| LLC                 | Limited                     | Pass-through        | Medium     | Growing businesses seeking flexibility  |
| C-Corp              | Limited                     | Double taxation     | High       | High-growth, capital-intensive startups |
| S-Corp              | Limited                     | Pass-through        | High       | Small businesses with U.S. owners       |
| Nonprofit           | Limited                     | Tax-exempt          | High       | Mission-driven organizations            |
+---------------------+-----------------------------+---------------------+------------+-----------------------------------------+

Conclusion

The choice of the right business structure is one of the most important parts of setting up a startup. Consider your business goals, how much liability protection you would want, and your tax situation, then follow through. Keep in mind that the best possible structure for your startup will likely change as your business grows, so be ready to reassess your choice from time to time.

In the next post, we will speak about “Founding LLC in United States with Stripe Atlas” and get into the details of how to use Stripe Atlas to smoothen your process of founding an LLC. Stay tuned for more insights and practical tips!

Knowing these structures of business will better place you as a founder to make an informed decision for your company that aligns with your goals. Choose wisely, and set your startup on its way to success.