All companies have a system of organization or power structure that helps provide leadership and guidance for the business. As a startup, the most common assumption is that the founder (or individual with an idea) will lead the company as it forms, grows, and matures. There are a lot of different organizational types available to entrepreneurs launching a startup. Each different organizational type comes with different consequences in terms of power, equity in the company, tax structures, and profit reporting.
So, what are the different organizational types for startups out there?
Sole Proprietorship
If you have an idea for a product or service and pour your blood, sweat, and tears into launching a startup, you might consider a sole proprietorship. You won’t have to file any documents to incorporate. You simply open up shop and start selling your product. You remain in control of the company and guide its decisions as it grows.
Like any choice, there are pros and cons:
• Pros
o Complete control
o Simplicity: easy to start and operate
o Inexpensive: little to no filing costs for legal documents
• Cons
o You are personally liable for all business obligations
o Limited ownership: bringing in a new owner ends the company’s existence as a sole proprietorship
Partnership
Forming your organization as a partnership comes with a lot of risk. General partnerships allow two or more individuals to share management of the entity, while a limited partnership establishes different classes of partners. General partners in a limited partnership have the ability to manage the day-to-day operations of the entity, while limited partners can determine who manages the company, but are not allowed to do so personally.
Pros and cons of partnerships include the following:
• Pros
o Multiple owners
o Simple to form and operate
o Flexible enough to adapt to changing needs
• Cons
o Each partner is liable for the obligations of other partners
o Partnerships dissolve when one party dies or withdraws, assuming safeguards are not in place to prevent dissolution
Limited Liability
The most common organizational type in this category is the Limited Liability Company (LLC). An LLC requires the filing of articles of organization with the secretary of state in the regions your business will operate. LLC offers a flexible form of ownership that is useful for tax planning.
Pros and cons include:
• Pros
o Members are shielded from personal liability stemming from business actions
o Members can be individuals, partnerships, or other entities
o Members can manage the business or elect a management group
o Incomes, losses, deductions, and tax credits flow through the business to individual members
• Cons
o Free transferability of interest is limited
o Cost: States charge initial formation fees and may even charge annual fees
S-Corporation
An S-corp is a hybrid entity that enjoys different tax treatment than standard corporations. S-corps operate in the same manner as a corporation, with directors, officers, and shareholders. However, an S-corp is taxed like a partnership.
Pros and cons include:
• Pros
o Cash accounting: no need to use the accrual method of accounting
o No earning and profits for the business, avoiding additional taxes as a result of personal holdings
• Cons
o Limit on the number of shareholders (100)
o Limited losses: not all losses and deductions can be claimed by shareholders
o Calendar year use, not fiscal year
o One class of stock available, restricting the ability to raise capital
There are a lot of different organizational types for startups. The specific type of organization you pursue as an entrepreneur should be determined through careful consideration of all pros and cons for each type. Compare those to the needs of you and your startup before selecting the right organization for your new business.
If you are ready to incorporate contact Inc. Plan for a free 30 minute consultation about your business. We can help find a solution that works for your business and answer remaining questions you have about starting a company.
