When it comes to launching a new business, one of the earliest decisions you will have to make is the type of business you will be operating and what it might mean for your plans. Of course, this often won’t be a straightforward decision to make. Still, there’s a lot to think about when deciding on the optimal business model for your new venture. And while it may be possible to switch business models down the line if you find your current one isn’t suitable, starting with the right model can often make a substantial difference for your overall profitability and/or success.
An Introduction to Business Classifications
Every business is unique – that should come as no surprise. However, there’s more to a business’s uniqueness than just the name and product range alone. Another differentiating factor is business classifications – and these directly determine the most suitable operating procedure for your business needs.
When establishing a business, you will need to choose a business classification to launch as. Many people initially launch as an unincorporated business while working out which option is right for them. However, this may not always be a good strategy. Indeed, while it’s possible to change your business classification after forming the business, this can represent additional hassles and a change to operating procedures, which may surprise your management team. Instead, choosing the most suitable model outright may be a much more practical option for your business.
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The Different Business Classifications You Should Know
There are four main types of business classifications you should know. These are sole proprietors / sole traders, partnerships, limited liability companies, and corporations. Alternatively, you could establish your business as a non-profit organization, although those may be outside of the scope of today’s guide, which focuses primarily on entrepreneurs looking to make a profit with their business rather than running the business specifically with a good cause in mind.
1. Sole Proprietorships / Sole Traders
One of the simplest business models is the sole proprietor model, which consists of a single business owner only – unlike all of the other business models on this list. As such, if you are planning to open a new business alone without any other owners, a sole proprietorship may be ideal.
Sole traders retain full control, ownership, and management rights over the company, and since the business income is part of the owner’s income, it’s also taxable on personal income and so will be liable for fewer taxes. Plus, it’s worth considering that the regulations from a paperwork perspective for sole proprietorships are substantially less.
There’s one significant challenge with sole proprietorships, however: they are liable for the business’s legal expenses. Since the owner and the business do not have separate legal identities, the owner may have to pay for any legal fees the business cannot afford – which means that the owner’s personal assets may be at risk with a sole proprietorship.
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2. Partnerships
Partnerships are very similar to sole proprietorships; however, there are multiple owners of the business. As such, if you are looking to start a new enterprise with multiple people – for example, a small shop with a father and son – a partnership may be a suitable business model. Partnerships are excellent for those wanting a simple model with limited paperwork and regulations, but it’s important to consider that each owner in a partnership remains liable for the business. However, limited partners may be able to reduce their liability to just the value of their initial investment in the firm, but this will reduce their level of control over the company.
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3. Limited Liability Companies
One of the most popular choices of business models for new entrepreneurs is a limited liability company or LLC. Indeed, though slightly more involved in terms of the set-up process and paperwork, these business models offer legal protection for their owners.
This is because limited liability companies are considered a separate legal identity from their owners, which means that their personal assets are not liable for loss during any legal cases. What’s more, since LLCs are not C corporations, they also still benefit from flow-through taxation.
You may choose to outsource the paperwork to online legal services such as ZenBusiness or Northwest. As such, if you have been considering ways to start an LLC business, you can consider hiring professional online incorporation services at a reasonable cost. Apart from being your professional registered agents, they can provide invaluable support for those looking to incorporate their business – and will be by your firm’s side to help, as well.
4. Corporations
A final option you could consider for your new business is a corporation business model – however, this is most commonly reserved for businesses that are larger in scale than a small firm due to the additional requirements of a corporation and its paperwork. What’s more, a corporation must also draft articles of incorporation and should issue shares to its stakeholders to purchase.
If you have been planning to open a corporation business, there are three main types. Of course, non-profit corporations are easy to understand, and the goal of these businesses is to spend any profits on achieving the business’s charitable goals. Meanwhile, you could also launch as either a C corporation or an S corporation; the former is more common and allows more shares to be sold. Meanwhile, the latter is more limited and can only have up to 100 shareholders (but benefits from pass-through taxation still).
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Which Business Model is Right for my New Venture?
If you’ve been looking to launch a new business, choosing the ideal classification is crucial. However, it may not always be easy, at the outset, to find the right type of business classification for your new enterprise’s needs. For example, operating as a sole proprietor may seem tempting if you’re only planning to be a small business.
Meanwhile, though, it’s important to consider that sole proprietary businesses have no legal protection. This means that you, as the owner, could face several key challenges with legal issues if your business faces a legal challenge.
However, if you choose to start an LLC business, it’s also worth considering that you will have to complete substantially more paperwork and the like, which may require additional support to keep your business operating smoothly. In any scenario, finding the right business classification for your needs can seem tough. However, with this in mind, there are plenty of advisors out there who may be able to help you find the business classification that’s right for your new venture.
So, if you’re unsure, don’t be afraid to ask for help from a business advisor. They’ll help point you in the right direction for your own entrepreneurial goals.
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