This post is part of a series designed to help you prepare to launch a high-impact startup.
Here, we focus on business structures common to the US.
Considerations
Your choice of business structure affects your organization’s legal liability, tax obligations, and ability to fundraise.
You’ll need to choose a business structure before you register your organization with the appropriate state. Choose carefully — while you may convert to a different business structure in the future, there may be restrictions based on your location.
Consulting with business counselors, attorneys, and accountants can prove helpful.
Types of business structure
There are five common business structures to consider:
- Sole proprietorship: The simplest business structure because it’s owned and managed by a single person. The owner is personally responsible for all business debts and liabilities, and reports business profits on their personal income tax return.
- Partnership: Owned by two or more people who share profits and losses. Partners have varying degree of responsibility for the partnership’s liabilities, and each partner reports profits on their personal tax return.
- Corporation: A separate legal entity owned by shareholders. It’s responsible for its own debts and liabilities, and profits are taxed separately from the owners’ personal income.
- LLC: A hybrid of a corporation and a partnership, offering the same limited liability protection as a corporation but with more flexibility in management and tax structure.
- Cooperative: Owned by and operated for the benefit of those using its services (”members”) who report profits on their personal tax return.
Many structures have special variants or sub-types which further affect taxation, fundraising, document filing, and liability. Read on to learn which structures are most suitable for which business, and what their common sub-types are.
| Business structure | Common sub-types |
| Sole proprietorship
A sole proprietorship is easy to form and gives you complete control of your business. You’re automatically considered to be a sole proprietorship if you do business activities but don’t register as any other kind of business. Sole proprietorships do not produce a separate business entity. This means your business assets and liabilities are not separate from your personal assets and liabilities. You can be held personally liable for the debts and obligations of the business, and personal assets (like a home or car) can be used to satisfy business debts. It can also be hard to raise money because you can’t sell stock, and banks are hesitant to lend to sole proprietorships. A sole proprietorship is likely not the right choice for your organization unless you want to test your business plan before forming a more formal entity. Example: Dr. Alan White, Independent Researcher in Renewable Energy, is a sole proprietorship. This allows the individual to control their business and own all profits; the risks around debts (e.g. from malpractice) are limited as a researcher. |
No common sub-types |
| Partnership
A partnership is the simplest type of structure for two or more people to own a business together. There are three sub-types of partnership: general, limited, and limited liability. These sub-types differ in the amount of personal responsibility that partners take for business debts and liabilities. In a general partnership, partners have unlimited liability, so are personally responsible for all business debts. General partnerships are uncommon and unlikely to be suitable for your organization, so we’ll focus on limited and limited liability partnerships in what follows. |
Limited partnership (LP)
A limited partnership has only one “general partner” — with unlimited liability — and all other partners have limited liability. The partners with limited liability also tend to have limited control over the company, which is documented in a partnership agreement. An LP is suitable for when a general partner is comfortable with unlimited liability, and wants to raise capital from investors who are comfortable with limited control — such as hedge funds. Profits are passed through to personal tax returns, and the general partner — the partner without limited liability — must also pay self-employment taxes. Example: Bloomberg LP is a limited partnership, which grants enormous control to its “proud” and wealthy founder, Michael Bloomberg. Limited liability partnership (LLP) A limited liability partnership is similar to a limited partnership, but gives limited liability to every partner/owner. An LLP protects each partner from debts against the partnership, they won’t be responsible for the actions of other partners. The flexibility of the partnership structure and the protection of liability makes this attractive to professional service firms with high exposure to malpractice claims — like law or accounting firms. Example: Deloitte LLP is a limited liability partnership, ensuring all of its partners are protected against malpractice claims. |
| Corporation
A corporation is a more complex type of structure for multiple people to own a business together. A corporation differs from a sole proprietorship or partnership in two crucial ways:
A corporation is more costly to set up and maintain than a sole proprietorship or partnership. But, based on the limited liability and collective ownership, it’s a strong choice for medium- or higher-risk businesses, or those that intend to fundraise. It’s also a strong choice for an organization that intends to the contribute to the public good, through sub-types such as a B Corp or nonprofit. |
C corp
A C corp is the default type of corporation. Example: Pfizer Inc. is a C corp, which allows it to raise significant capital from public and private investors — especially as C corps can issue multiple classes of stock (unlike an S corp). S corp An S corp is a type of corporation that avoids the “double taxation” whereby the legal entity and its owners both get taxed (through corporate tax, and income tax, respectively). Instead, an S corp allows profits (and some losses) to be passed through directly to owner’s personal income, and avoid corporate tax. Not all states tax S corps equally, and some states don’t recognize the S corp election at all, simply treating the business as a C corp. An S corp can be a good choice for a business that would otherwise be a C corp, but meet the criteria to file as an S corp. Example: The Cheesecake Factory Incorporated is an S corp, which enables it to avoid corporate income tax. In return, ownership is limited to 100 domestic shareholders. Benefit corporation A benefit corporation differs from a C corp in purpose, accountability, and transparency, but not in taxation. A benefit corporation is driven by both mission and profit, and is held accountable to producing some public benefit by its shareholders and/or state regulation. Not all states recognize benefit corporations, although a majority do. (A “B Corp” is a specific type of benefit corporation, which is held to standards by a specific third-party: B Lab.) Example: Patagonia Inc. is a benefit corporation, ensuring it stays true to its mission: “Build the best product, cause no unnecessary harm, use business to inspire and implement solutions to the environmental crisis.” It has since become managed by a broader purpose trust with a wider mission: “To save our home planet.” Close corporation A close corporations resembles a B corp but has a less traditional corporate structure. Shares are usually barred from public trading, and a close corporation can be run by a small group of shareholders without a board of directors. A close corporation is not a common type of corporation, but can be a viable alternative to a B corp for a smaller company. Example: Chick-fil-A is a close corporation, which ensures that its founder retains control of its direction. This was important to a founder with deeply-held religious convictions (e.g. Chick-fil-A is closed on Sundays to respect the Sabbath; its stated mission is “To glorify God by being a faithful steward of all that is entrusted to us.”) Nonprofit A nonprofit corporation is organized to do charity, education, religious, literary, or scientific work. Because its work benefits the public, a nonprofit may be eligible for tax-exempt status, meaning it doesn’t pay state or federal income taxes on any profits it makes. A nonprofit needs to follow organizational rules very similar to a regular C corp, but is subject to more requirements around reporting and the distribution of profits (which is forbidden to members or political campaigns). The most common type of nonprofit is a 501(c)(3). Example: Code for Science and Society is a 501(c)(3) nonprofit, ensuring it provides public benefit through its projects in research and technology. |
| Limited liability company (LLC)
A limited liability company (LLC) offers the liability protection of a corporation, with the tax benefits of a partnership (i.e. no corporate tax). An LLC has no shareholders, just members. Members share in the profits of the business, but are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security. This makes an LLC typically less attractive to investors, as it complicates their tax returns. When a member joins or leaves an LLC, some states may require the LLC to be dissolved and re-formed with new membership — unless there’s already an agreement in place within the LLC for buying, selling, and transferring ownership. An LLCs can still be a good choice for a medium- or higher-risk business where owners want to pay a lower tax rate than they would with a corporation. Example: Google became an LLC upon the creation of its parent company, Alphabet Inc. This means Google LLC avoids corporate tax and board meetings; and gives Alphabet Inc. more flexibility in reporting its results across a number of subsidiaries. |
No common sub-types |
| Cooperative
A cooperative is a business or organization owned by and operated for the benefit of those using its services. Profits and earnings generated by the cooperative are distributed among the members, also known as user-owners. Typically, an elected board of directors and officers run the cooperative while regular members have voting power to control the direction of the cooperative. Members can become part of the cooperative by purchasing shares, though the amount of shares they hold does not affect the weight of their vote. A cooperative can be a good choice for groups that want to collaboratively own and operate an enterprise to serve their common needs, such as those focused on community development and social enterprise. Example: People’s Food Co-op is a cooperative, ensuring that its members (patrons) retain ownership and benefits, rather than a distant set of directors or investors. |
No common sub-types |
Hybrid structures
You might also intend to create a nested or hybrid structure, combining multiple types of business in a higher-level arrangement. These arrangements are far less common and can be more difficult to set up. If you’re considering one of these non-standard structures, you should consult an attorney to help you decide.
Parent-subsidiary relationships
Examples of parent-subsidiary relationships include:
- C corp owned by nonprofit. This can be suitable for a nonprofit looking to generate additional revenue to support its mission, or to separate its charitable and commercial activities for operational clarity and/or legal protection. An example of this structure is the Mozilla C corp being owned by the Mozilla Foundation nonprofit.
- LLC owned by nonprofit. This can be suitable for the same reasons, albeit with the tax benefits (and administrative costs, especially if operating in multiple states) of an LLC. An example of this structure is the OpenAI Global LLC being owned by the OpenAI, Inc. nonprofit.
- Purpose trusts. A purpose trust is a legal arrangement where a trustee holds and manages assets to achieve a specific purpose outlined by the grantor (the person who creates the trust). It is not a legal entity in the same way a (nonprofit) corporation is. Instead, it is a fiduciary relationship involving the trustor, trustee, and sometimes an enforcer (for non-charitable purposes). A purpose trust is created to achieve a specific objective or purpose rather than to benefit individual beneficiaries. Unlike traditional trusts, which have identifiable beneficiaries (such as family members), a purpose trust is designed to carry out a particular purpose. This could include charitable purposes, the maintenance of specific assets, or other non-charitable objectives that do not have clear beneficiaries. An example of a purpose trust is Patagonia (which manages Patagonia Inc., the benefit corporation).
- Fiscal sponsorship. This can be suitable for smaller projects looking to receive tax-exempt status and/or administrative services from a larger nonprofit. Or, conversely, for larger nonprofits to support grassroots initiatives or temporary projects within their own business structure. Examples of this structure include the fiscal sponsors Science and Technology Futures, Code for Science & Society, and Players Philanthropy Fund (and their associated projects).
Note that while a nonprofit can own a for-profit corporation, a for-profit corporation cannot own a nonprofit. This is because a nonprofit has no owners, legally — only trustees/directors. However, a for-profit corporation can work closely with a nonprofit (e.g. supporting it with funding) in a way that practically gives it influence over the nonprofit.
Legally independent but coordinated entities
Two legally separate entities that coordinate their operations (e.g. through a Memorandum of Understanding or “MOU”). The MOU outlines the relationship between the entities, covering aspects like resource and data sharing, brand licensing, and joint governance practices. The entities remain legally independent but act in a coordinated manner.
Overlapping boards can exist within the governance option but each entity should have a quorum of independent directors so that decisions can be made independently.
Multinational organizations
You might also intend to set up a multinational organization. The entities within a multinational organization may be related through either parent-subsidy relationships (i.e. foreign subsidies) or as legally independent but coordinated entities.
- A C corp is particularly well-suited for this due to its ability to raise capital through stock offerings, and its formal legal structure.
- An S corp is unsuitable for this, since it must be a US based entity with US shareholders.
- Other business structures vary in suitability (e.g. partnership laws, B Corp certifications, and tax-exempt activities can vary from country to country).
You can also combine multiple structures internationally.
Decentralized autonomous organizations (DAOs)
Decentralized Autonomous Organizations (DAOs) represent a novel and emerging form of organization that operates using blockchain technology and smart contracts.
DAOs must navigate existing IRS business structures and regulations, often classifying themselves as partnerships, corporations, or LLCs (and therefore paying taxes appropriately). Despite the challenges posed by their decentralized nature — e.g. the fact that members are often anonymous, yet responsible parties for tax filings must be identified — DAOs can achieve compliance through strategic structuring, professional guidance, and proactive record-keeping.
As regulatory landscapes evolve, more tailored frameworks for DAOs may emerge, further clarifying their status and obligations.
Narrowing it down
The appropriate business structure for your organization will depend on a variety of considerations, and how you weigh them.
We’ve already seen how your choice of business structure affects ownership, liability (e.g. for business debts), and taxation. Now, it’s worth reflecting on your business plan, and further considerations, in order to narrow down the search space.
Based on your business plan
Having prepared your business plan, you may notice that elements of your business model make it more or less suitable for certain types of business structure.
For example:
- Your cost structure might flag some expensive resources you need to acquire. Substantial fundraising might be required to secure those resources, which might be conducted through investments in a corporation, or perhaps tax-deductible donations to a 501(c)(3) nonprofit.
- Your key activities might involve partisan political activity, which would not be suitable for a 501(c)(3) nonprofit — but could be suitable for a different type of nonprofit, like a 501(c)(4).
- Your customer relationships may depend on a perception of contribution to the public. A business model with accountability for public goods, like a nonprofit or B corp — or a hybrid or nested structure including one or both — may therefore be useful.
Based on further considerations
Secondly, you may want to consider structure-specific features that don’t otherwise appear in your business plan. For example, with respect to any given business structure, you might ask:
- Which funding sources are available for it?
- Does it restrict compensation for staff?
- Are there long-term incentives for staff?
- Are there mechanisms for ensuring its activities remain in the public’s interest?
- What are its implications for the scientific community?
- How is the organization formed — and how long does that take?
- How is the organization regulated?
We suggest you take some time to figure out which business structure is right for your organization, taking into account these considerations, and how you weigh them.
Stay tuned for our next post: Choose a state.