Read about different types of small businesses, including sole proprietorship, partnership, corporation, and S-Corporation.
What are 4 Types of Small Business: There are many types of small businesses, but there are just four primary business models that represent the vast majority of the small business landscape in America. These four types of small businesses are sole proprietorships, partnerships, corporations, and limited liability companies (LLCs).
What are 4 Types of Small Business?
Understanding which type of business model you should adopt is crucial to ensuring your success as an entrepreneur since each form has its own pros and cons, tax implications, and legal requirements. Below we’ll take a look at the four types of small businesses available to entrepreneurs today and explain what they mean to your bottom line and overall success as an entrepreneur.
Sole Proprietorship
In a sole proprietorship, an individual owns and operates a business by himself. In most cases, there is no legal distinction between his personal assets and those of his business. For example, if there’s a lawsuit against a sole proprietor, it can affect both his home and any money he has in savings or checking accounts—all are considered to be part of his business. With that said, while such risks are possible they’re not very likely.
Since everything’s tied together under one owner who might have little experience or education in finance or law (in other words, someone lacking formal expertise), it makes it much less likely for something like fraud to happen. In fact, according to some estimates only, 1% of all sole proprietorships end up with criminal charges filed against them. On top of that, many small businesses don’t need to pay taxes until they reach $400,000 in revenue per year.
That means their profits are completely tax-free until then! If you start a sole proprietorship and stay below $400k in annual revenue for three years running (as long as you remain unincorporated) you never have to pay taxes on your profits at all! This is why so many people choose to start out as sole proprietors. It’s also important to note that in addition to having freedom from income taxes, a sole proprietorship also provides significant flexibility when it comes to paying yourself.
You can take out all of your earnings immediately or you can put them back into your business whenever you want. This isn’t always true with corporations and LLCs where distributions must often follow specific rules based on how much money was earned during each fiscal quarter. When starting out, flexibility might be more important than maximizing profit potential—especially if you plan on putting back extra cash into growing your company over time.
Partnership (LLC and LP)
If you’re planning to have more than one owner of your business, then consider a partnership. Both LLCs and LPs are easy to establish, relatively inexpensive, and come with few ongoing maintenance requirements. One advantage a partnership has over an S-Corp is that its liability protection extends to all partners in addition to corporate shielding. Partners can also take advantage of pass-through taxation, which means they will only pay taxes on business profits once and not twice as owners do for S-Corps.
On top of that, profits from an LLC or LP can be easily distributed among shareholders if members so choose. However, partnerships are susceptible to disputes between co-owners and can result in personal financial ruin if disagreements turn ugly. (If you want to learn more about how partnerships work, check out our guide here.)
As alluded to above, partnerships don’t shield individual owners from potential bankruptcy. That said, there are ways partners can protect themselves financially even without corporate structures in place — namely through collateral agreements and nonrecourse loans.
Collateral agreements allow investors to loan money against specific assets instead of issuing traditional debt instruments and nonrecourse loans force secured creditors to assume the worst-case scenario before seizing collateral when faced with insolvency risk. This way, lenders who fear that their collateral may lose value due to negative economic circumstances will still extend credit but won’t seek payment outside of bankruptcy proceedings.
(For more on how you can safeguard your personal finances as a business owner, check out our partner’s guide here.) If you’re starting a business with one or two other people, then a partnership might be for you. But if you want protection from potentially litigious co-owners or just prefer more liability shielding for your buck, then an S-Corp is likely a better fit. For more information on how partnerships work and how they compare to S-Corps, check out our free resource here.
Corporation
This type of business provides owners with liability protection. It’s also more complicated to set up and maintain, which is why it’s typically used by larger businesses with more funding. Corporations are legally separate from their owners and shareholders, allowing those individuals to be responsible for specific parts of business activities while holding other elements in a separate, legal entity.
If you choose to incorporate your small business, look into forming an S corporation or a limited liability company (LLC) because these structures offer additional tax advantages that protect personal assets from business liabilities. Most states allow corporations to operate under Doing Business As names (or DBA), but some require official registration. Most states also require corporations to file annual reports and pay annual fees.
Some cities may have additional requirements as well. To learn more about incorporating your business, check out Incorporate Your Business. You can also find details on registering a DBA name at Nolo. Incorporating isn’t right for every small business—some entrepreneurs prefer operating as sole proprietorships or partnerships because they don’t want their personal assets tied up in case of bankruptcy or lawsuits against their companies.
You can also register your business as a limited liability company (LLC) if you’re worried about potential lawsuits and need to protect your personal assets. An LLC offers its owners protection from legal claims, but it doesn’t provide liability protection like a corporation does. If you choose to register an LLC, you’ll have to file articles of organization with your state government and pay an annual fee.
To learn more about LLCs, check out Nolo’s Limited Liability Company area. You can also find details on registering a DBA name at Nolo. You may also want to consider forming a limited partnership if you’re concerned about potential lawsuits and need to protect your personal assets from being seized by creditors or others who might make claims against your company.
Franchising
If you’re a big fan of franchising but don’t have $100,000+ to throw at a major brand name, consider starting your own franchise. Because its startup costs are relatively low, a franchise can often be more affordable than venturing out on your own and establishing a new business from scratch. On top of that, franchising already has customers in place and a developed infrastructure that you can use for your company — they just need another helping hand to make sure things run smoothly.
If you love operating under someone else’s corporate rules but can’t afford their fees or brand-name recognition, check out franchising as an option for starting your small business. You’ll have a lower risk investment (compared to self-starting) and you’ll still get all of those famous perks like marketing support, established locations, and training materials. There are several franchises available if you’re interested in taking a peek into what options might work best for your particular skill set.
Franchises can vary widely depending on what type of industry they operate within; so think about which industry would best suit your skillset or personality type when researching different franchises to buy into. Once you’ve decided on a few possibilities, do some research to see how much it will cost to start up with each one. Remember, not every franchise is going to be equally priced. Many times, newer companies charge less than older ones because they’re looking for ways to draw in new buyers who are excited by their prospects of growing with them and potentially making lots of money down the road.
That said, newer businesses aren’t always better businesses — many entrepreneurs believe that more mature companies tend to offer better products/services with fewer risks involved (they’ve been tested out by consumers and adjusted accordingly). As long as you do your homework before jumping into any business venture, chances are good that you’ll find something worthwhile within whatever category appeals most to you.
Also Read: What Business Can I Start With 5000?
Conclusion
When you are starting a small business, it is important to know what type of small business entity you will create. Keep in mind that each type has different legal and tax implications that you should be aware of before creating your company.
For example, a corporation requires more paperwork and is subject to more government oversight than an LLC or sole proprietorship. Additionally, a certain type may affect your ability to raise money through outside investors down the road.
Regardless of which type you choose, read up on all aspects and weigh your options before going forward with any one particular structure. As always, if you have questions about how to start a small business, consult with a lawyer specializing in small businesses and talk with local officials regarding permits and licenses needed for your business.
