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Types of Businesses: Which Legal Structure Is Right for Your New Venture?

Which Type of Business Do You Run? How to Incorporate and Make Your Business Legit

Starting a business is a challenging and rewarding process. Choosing your name, customizing your site, sourcing your products, and finding your first customers are necessary and often fun parts of running your company.

But does a website and a logo make you “legit”? And, more importantly, do they protect you as a business owner in case something goes wrong?

While it’s not the most glamorous work, business incorporation is the bedrock on which your business is built. When you incorporate your business, you establish it as a legal entity recognizable by the government. Let’s find out what this means, why you should do it, and how to get started.

Why your business structure matters

Your business structure determines how you’re taxed, what your liabilities are, and how you’ll secure funding and capital, among a host of other factors.

There are plenty of benefits to incorporating your business, some of the most important being:

  1. Protection of personal assets
  2. Transferable ownership
  3. Potential for lower taxes
  4. Easier to secure business funding
  5. Separate credit rating regardless of an owner’s personal score
  6. Simpler to create retirement plans

Every business structure offers different benefits for personal liability, ownership, taxation, and funding, among other aspects.

Types of business structures

While each business type has benefits, certain types of businesses are better-suited for different company structures. You can also change your business structure as your business evolves over time, though this comes with additional administrative steps.

Sole proprietorship

A sole proprietorship is an unincorporated business without a legal distinction between the company and the individual who owns and runs it. It’s arguably the most straightforward business structure and is simple to set up and manage.

Some new ecommerce businesses with low startup costs and a low risk of liability use sole proprietorships. A sole proprietorship can evolve into another business type later—in fact, it has to if you add to your team—but is the fastest and easiest way to start.

A sole proprietorship qualifies as a non-employer business. These types of businesses have no paid employees, and they’re one of the most common types of businesses in the US. About 40% of small business owners have a non-employer business as their main source of income, while 60% use it as a supplementary source.

Advantages of sole proprietorship:

  • Lower taxes. With a sole proprietorship, you only have to do your taxes once, whereas an LLC requires you file state and federal taxes separately. The company doesn’t file taxes, but the owner does.
  • Complete control of your business. Because you don’t have any partners or investors to consider—it’s all on you—you get to make every business decision the way you want.
  • Easy to change your structure in the future. If you start out as a sole proprietorship, you’re not stuck with that company structure. You can change to a different type of business at a future date, whenever you’re ready.

Disadvantages:

  • Personal liability. With a sole proprietorship, taxes need to be filed under the individual who owns the company. This adds risk because there’s no distinction between the individual and the company, so the individual is personally liable for everything the company does. Thus, the individual’s personal assets are on the line.

Partnership

Partnerships are single businesses with two or more owners. Each of these owners or partners contributes to the business through funding, property, labor, skill, or something similar. They also share the profits from the company.

There are two types of partnerships:

  1. General partnership (GP). A general partnership assumes the business is either evenly divided or split into percentages that have been documented and agreed upon beforehand.
  2. Limited partnership (LP). A limited partnership can limit both control and liability for specified partners.

Partnerships follow a pass-through taxation model. This means the owners are taxed rather than the business. Taxes are applied based on each partner’s income from the business, not the business’s revenue.

Advantages of partnerships:

  • Share the responsibility. There’s a saying about “power in numbers”—and you could say it applies to a partnership. Rather than bearing all the burden yourself, you can share it with your partner. This also grants you more access to capital in many cases.
  • Simple to start and manage. It’s relatively easy to establish an official partnership. And in terms of ongoing management, you have fewer tax forms than other business structures.

Disadvantages of partnerships:

  • Partner conflicts. In most partnerships, both parties don’t always agree on every single decision. Many compromise, but over time this can cause conflict between owners and within the company. It’s important to make sure you and your partner are on the same page when you enter this agreement.
  • Personal liability. Because taxes for partnerships don’t include a distinct separation of the business from the individual, owners assume more personal risk. Plus, owners pay individual taxes instead of the business paying taxes, and this can result in a greater amount owed.

Corporation

A corporation is a legal entity separate from a person, so owners are free from personal liability, except for rare and extenuating circumstances. Instead, a corporation assumes all the risk instead of passing it on to the people who own and run it.

Corporations are also more easily transferred to new owners compared to other business structures. Like other types of business, you file your corporation with your state. Each jurisdiction has its own specific parameters for corporations, but pretty much all corporations are required to pay local, state, and federal taxes, each of which are filed separately from shareholders’ taxes.

Corporations may or may not pay lower taxes than individuals. This varies by state, so it’s a good idea to compare individual tax rates—for sole proprietorships vs. LLCs vs. partnerships—with corporate tax rates. In many cases, the corporation will pay less, but consult a tax professional to be sure.

In some cases, shareholders of small companies may get taxed twice. Specifically, the corporation will pay taxes on its profits and then the shareholders will pay taxes on their share of the profits in the form of personal income.

Advantages of a corporation:

  • Reduced risk. The primary benefit of forming a corporation is that, regarding the corporation’s assets or debts, a shareholder’s personal property is protected. For example, if a customer sues a retail corporation and wins, the corporation would be forced to pay. If the corporation doesn’t have enough money to pay, the liability isn’t passed on to shareholders, so they wouldn’t have to make up the difference.
  • Raise capital through shares. Corporations can sell shares to raise capitall. This makes corporations more attractive to some workers because it signifies stability and reliable compensation—if the corporation runs out of cash, it can always sell shares.

Disadvantages of a corporation:

  • More work to incorporate and maintain. Generally speaking, corporations are more difficult to form and manage than other business entities. There’s more setup, and you have to carefully maintain the business as a separate legal entity every step of the way.
  • Personal liability isn’t completely eliminated. If the corporation’s records are improperly managed, you could be more personally liable than expected. When attorneys sue corporations and prove the corporate records weren’t maintained and the corporation wasn’t acting like a separate legal entity, they’ve “pierced the corporate veil.” In other words, you lose protection for personal assets.

Limited liability company (LLC)

A limited liability company, or LLC, is a hybrid business structure, combining the ease of a partnership with the liability protection found in corporations. It’s technically a type of corporation.

Owners, frequently called members, pay taxes on the LLCs profits directly—the LLC itself doesn’t file taxes as a separate legal entity. LLCs with at least two members get the option to be taxed like partnerships or corporations if they prefer. This taxation election eliminates the separation of business and personal taxes.

LLCs are a newer business type, and they’re becoming increasingly popular. According to data from the IRS, while other corporate structures have declined since the 1980s, LLCs have experienced an upward trajectory.

Depending on the state, LLCs may have a limited lifetime. In some jurisdictions, the LLC is dissolved when a member leaves. Ultimately, an LLC is a great business structure for a single founder who is just starting out.

Advantages of an LLC:

  • Simple management. LLCs require a lot less record keeping and have fewer profit sharing requirements than corporations in particular. It’s a relatively simple and straightforward business structure that works for small/medium and early-stage businesses.
  • Personal protection. With an LLC, your personal assets have a level of protection that reduces your liability.

Disadvantages of an LLC:

  • Not available for all businesses. Each state has parameters around which types of businesses and industries are eligible for LLC status. Commonly prohibited businesses include banks and insurance companies. Special rules also apply to foreign LLCs.
  • State and federal taxes. LLC members will have to file additional forms for both federal and state taxes depending on the number of members, local laws, or even the LLC’s articles of organization. Often the members of an LLC pay payroll tax too.

Learn more: How to Start an LLC

How to choose your business structure

There isn’t an easy answer or formula for every new business to follow when selecting a structure. Many online retailers start as sole proprietorships or partnerships and wait to incorporate when the company’s potential liability makes protecting personal assets attractive or when being able to sell shares of the business would help it grow.

Ultimately, contacting an attorney will be the safest way to decide which business structure is best for you and your company. Here are some things to think about in the meantime.

Personal liability

One of the advantages of business incorporation is that it creates a separate entity from you as an individual. As such, this also reduces your personal risk in many cases. Some business structures offer stronger protections for owners, like a corporation. Others offer less in the way of personal protection, like a partnership. You have to decide how much personal liability you’re willing to take on.

Learn more: How to Get a Business License: A State-by-State Guide

Hiring employees

If you’re hiring employees or have plans to, this influences which corporate structure you choose. Sole proprietors, for example, can’t hire employees. So you can start out as an S prop but will need to file to change your business structure if you plan to onboard any staff.

Bringing on partners

Likewise, if you plan to have a partner in your business, you’ll need to choose a business structure that supports that. So instead of a sole proprietorship, you’ll look to set up an LLC with multiple members, a partnership, or a corporation.

Business funding

You might come to a point in your business where you need funding for product development, store expansion, inventory investments, or other necessary expenses. There are multiple ways to raise capital for your ecommerce business. But the likelihood of success depends on many factors—one of those being your business structure and history.

When you incorporate, you can build credit and a financial history for your business. Potential lenders, investors, and other sources of capital will look at this information to determine your business’s eligibility for funding. A strong history and credit standing will increase your chances at securing financing and low interest rates.

With funding from Shopify Capital, you can make your next big move with confidence.
With funding from Shopify Capital, you can make your next big move with confidence.

Incorporating your business

The actual act of incorporating your business requires a few administrative steps. You can do everything yourself, use an expert’s guidance, or outsource the entire process. If you want to hire an expert, browse through Shopify Experts to find qualified pros and sales tax experts who can help.

At a glance, you’ll need to take the following steps to officially incorporate your business:

Decide where you’ll incorporate your business

For some business owners, where you incorporate is going to be straightforward. If you operate and sell locally, you’ll likely opt for the state where you do business. But if you have plans to sell across the country, and even internationally, there’s more to this decision than you might think.

Each state has its own set of requirements for each business structure, as well as its own application, taxation, and administrative parameters. Check your state’s requirements and apply for your state license here.

Choose your business name

Your business name, or a variation of it, will likely be how you’re known to the public. For example, you might refer to General Electric as “GE” but its actual corporate name is General Electric.

If you’re feeling stuck on your name, you can use this guide to choosing a business name to spark some ideas. When you do have an idea you like, perform a search in your state’s database to ensure no one else has claimed it before you.

Apply for your Employer Identification Number

Your Employer Identification Number, or EIN as it’s commonly known, is a federal tax ID. It functions similarly to how your Social Security number functions—you use it when you file paperwork and taxes with the government. This is how the government identifies your business. You need your EIN to incorporate your business.

To register for your nine-digit EIN, all you have to do is fill out this form on the IRS website. You’ll get your EIN immediately.

File your paperwork and/or articles of incorporation

Once you have your EIN and a chosen name, you can file the paperwork with your state to make it all official. If you’re filing a corporation, you’ll need to include articles of incorporation with this application. Essentially, all of this administrative paperwork contains information about your company, its founders/partners/members, and its shareholders. These documents make your business official.

Take the next steps with Shopify

Incorporating your business makes it official in the eyes of the government. You’ll protect your personal assets, build credit and history for your company, and even enjoy lower taxes in some cases. But the best benefits of business incorporation are perhaps intangible. Incorporation transforms your idea into a real, official business—the rest is up to you.



 


Business structure FAQs

What are the 4 types of business structures?

The four types of business structures covered in this post are:

  1. Sole proprietorship
  2. Partnership
  3. Corporation
  4. Limited liability corporation (LLC) (technically a type of corporation)

Which type of business is best?

The best type of business entity depends on your unique business needs. This post guides you through the types of businesses and how to choose the best one for you.
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