I once worked with a founder who picked an LLC because “it sounded official.” It worked until they needed to raise money and issue equity. Six months later, they had to restructure everything, burning $3,000 in legal fees, just to get back on track. *gulp* 🙁
The legal structure might seem like boring paperwork, but it shapes your taxes, liability, ownership rights, investor options, and how easily your business can grow.
If you're unsure how to choose the legal structure of a business, this blog lays it out clearly. You'll get practical comparisons, a breakdown of each structure, and real-world context, so you don’t make an early decision that limits your future. Start smart.
What is a business legal structure?
A legal structure is your business's formal identity in the legal system. It defines who owns the business, how it’s organized, and what legal and administrative rules apply to it. It also informs your company overview, especially when you're outlining ownership, liability, and governance in a business plan.
Each structure comes with its own rules. That includes how records are kept, what forms you file, and who makes decisions.
Here’s what the legal structure of a business plan controls:
- Liability: Who is legally responsible for obligations or debts
- Taxes: How profits are reported and taxed
- Compliance: Whether formal roles or filings are required
- Fundraising: If and how you can offer ownership or equity
Types of business structures
Every business needs a legal identity. Whether you're running solo or with partners, aiming small, or planning to scale, your business legal structure decision sets the foundation. Let’s walk through the main options and what each one actually means in practice.
| Legal Structure | Liability | Taxation | Ease of Formation | Suitable for |
|---|---|---|---|---|
| Sole Proprietorship | Unlimited personal liability | Pass-through (personal tax reported on owner’s return via Schedule C) | Very easy | Freelancers, consultants, and solo owners with minimal risk or startup cost |
| Partnership | Unlimited personal liability (general) / Limited liability (limited partners) | Pass-through (personal tax) | Easy | Co-founders who trust each other and want shared control |
| LLC | Limited liability | Pass-through (default); can elect corporate tax | Moderate | Startups or small businesses wanting liability protection without red tape |
| Corporation (C Corp) | Limited liability | Double taxation (corporate and personal) | Complex | High-growth startups raising VC or planning to go public |
| S Corporation | Limited liability | Pass-through (must file IRS Form 2553 to elect S Corp status) | Complex | Profitable small businesses seeking tax efficiency and liability protection |
| Cooperative | Limited liability | Pass-through (cooperative tax benefits) | Moderate to complex | Member-run groups like co-ops, credit unions, or community organizations |
1. Sole proprietorship
A sole proprietorship is the simplest form of operating a business. There is no legal distinction between yourself and the business—you are responsible, and you are personally liable for everything that goes on.
You don't need to send in any official papers to begin. If you're the sole owner, it's done automatically. That being said, if you're operating under a business name rather than your own, you may require a local permit or a DBA (Doing Business As) filing.
All revenue and expenses are directly attributed to you and reported on your own tax return, usually via Schedule C—Form 1040 in the United States.
Pros
- Easy and low-cost to start: You don’t need any legal filings to operate, which means minimal red tape.
- Complete control: As the sole owner, you make the calls without any partners, boards, or voting.
- Tax simplicity: You report everything on your personal return.
- Easy exit: If you decide to stop, there’s no formal shutdown process.
Cons
- You're liable for everything: If the business owes money or gets sued, your personal assets are at risk.
- Tougher to raise money: You can’t offer shares or equity, so funding often depends on your savings or personal credit.
- Tax pressure: All profits count as personal income, which can increase your tax bill and include self-employment taxes.
- No continuity: The business has no separate existence, so if you stop operating, the business ends with you.
Best for: Freelancers, consultants, or solo business owners with minimal risk or startup cost.
Example: Pat Flynn’s Smart Passive Income. Started as a solo blog and turned into a large personal brand. Flynn operates as a sole proprietor for several of his digital products.
2. Partnership
A partnership is an enterprise shared between two or more individuals. Two people starting up and failing to register as an independent legal entity will automatically enter a general partnership by default.
There are two primary forms: General partnerships, in which all partners have management responsibilities and personal liability, and limited partnerships, in which one or more partners provide capital but don't run the business and are only liable to the amount they invested.
Profits and losses flow through to the personal tax return of each partner. Typically, each partner reports their share on Schedule E—Form 1040, supported by a Schedule K-1 issued from Form 1065 filed by the partnership.
Even though formal registration is not always necessary, it is highly recommended to have a written partnership agreement that defines ownership, duties, profit-sharing, and terms of exit.
Pros
- Shared responsibilities and complementary skills: Each partner can focus on their strengths, splitting the workload and decision-making.
- Easy to set up with few formalities: Most partnerships don’t require formal registration beyond a basic agreement and local licensing.
- Pass-through taxation: Business profits are taxed once—on each partner’s personal tax return, avoiding the double taxation that applies to corporations.
Cons
- Partners are personally liable (in general partnerships): Each partner is on the hook for the business’s debts and legal liabilities, even those caused by the other partner.
- Potential for disputes: Disagreements over money, direction, or roles can cause serious friction if not clearly outlined in a partnership agreement.
- Shared profits, even if the effort is uneven: Profits are divided regardless of how much each partner contributes unless the agreement says otherwise.
Best for: Two or more co-founders who trust each other and want a simple shared ownership model.
Example: Ben & Jerry’s (initially). Started as a general partnership between Ben Cohen and Jerry Greenfield before converting to a corporation as they scaled.
3. Limited Liability Company (LLC)
An LLC is a flexible business structure that offers liability protection with simpler tax and operational requirements than a corporation. It’s become a favorite for small and medium-sized businesses.
You form an LLC by filing paperwork with the state. Members (owners) can be individuals or other businesses. The default tax treatment is pass-through, with single-member LLCs filing taxes on Schedule C—Form 1040, and multi-member LLCs reporting through Schedule E—Form 1040 using K-1 forms (from Form 1065). LLCs can also elect to be taxed as a corporation, in which case Form 1120 or 1120S is used.
You form an LLC by filing paperwork with the state. Members (owners) can be individuals or other businesses. The default tax treatment is pass-through, but you can elect to be taxed as a corporation. LLCs offer liability protection without requiring boards or shareholders.
Pros
- Limited liability protection: Members are not personally liable for business obligations or lawsuits, provided personal and business finances remain distinct.
- Less formalities: LLCs have fewer compliance needs compared to corporations, no requirement for mandatory board meetings, annual reports, or shareholder votes in most states.
- Ownership flexibility: LLCs can have a single or multiple members, and the members can be individuals, businesses, or foreigners.
Cons
- State-specific rules and fees: Some states charge high formation or annual fees and impose extra requirements, which add complexity.
- Constrained fundraising alternatives: In contrast to corporations, LLCs are not able to issue stock, potentially complicating it to raise funds from some investors.
- Self-employment taxes: Members usually pay self-employment tax on the whole business profit unless the LLC is a corporation.
Best for: Startups or small businesses wanting liability protection without corporate red tape.
Example: Zappos operated as an LLC during early growth stages before being acquired by Amazon.
4. Corporation (C Corporation)
A C Corporation is a distinct legal entity from its owners (shareholders). It has the ability to own property, enter into contracts, be sued, and raise capital by issuing stock, so it is the structure of choice for companies that intend to grow or go public.
To set one up, you’ll file Articles of Incorporation with the state, create bylaws, appoint a board of directors, and issue shares. C Corporations follow strict reporting rules, hold regular board and shareholder meetings, and keep detailed records.
Profits are doubly taxed, first at the company level and secondly when paid out to shareholders as dividends. The corporation files Form 1120 to report its income, and any dividends paid are reported by shareholders on Schedule B—Form 1040.
While the structure is complex, it opens doors to institutional funding, IPOs, and more flexible equity arrangements.
Pros
- Strong liability protection: Shareholders aren't personally responsible for business debts or lawsuits, but their investments are at risk.
- Easier to raise capital: Can issue multiple classes of stock and attract VCs, institutional investors, or go public.
- Unlimited ownership potential: No cap on the number of shareholders or who they are (individuals, other companies, foreign investors, etc.)
Cons
- More paperwork and rules: You need a board, regular meetings, and annual filings, such as noncompliance risks and losing liability protection.
- Higher setup and maintenance costs: Formation fees, legal help, and tax filings make it costlier than other structures.
- Less direct control: If you bring in shareholders or investors, decisions may shift from you to a board or majority vote.
Best for: High-growth startups planning to raise venture capital or go public
Example: Apple Inc. is structured as a Delaware C Corporation, suitable for public trading and global investor access.
5. S Corporation
An S Corporation is a tax designation that enables a C Corporation to distribute income directly to shareholders, in turn escaping double taxation. It's legally still a corporation and must have Articles of Incorporation, bylaws, and a board.
To make your business an S Corporation, you need to first incorporate the business as a normal corporation and then apply IRS Form 2553 to elect S Corp status. In this arrangement, the business enjoys the legal protection of a corporation but with simplified taxation.
S Corporations file Form 1120S, and profits or losses are reported by shareholders on Schedule E—Form 1040 using K-1 forms (from 1120S).
But you have to have 100 or fewer shareholders, all of whom have to be U.S. citizens or residents, and you can only have one class of stock.
Pros
- Pass-through taxation: The corporation as such does not owe federal income taxes; income and losses are reflected on shareholders' individual tax returns.
- Limited liability protection: As with any corporation, shareholders are not individually responsible for business liabilities or lawsuits.
- Tax efficiency for owners: Owner-employees may draw a salary and receive income in the form of dividends, which can save overall self-employment tax.
Cons
- Ownership limitations: Shall have not more than 100 shareholders who are all U.S. residents or citizens, but no partnership or corporation—no corporations or partnerships.
- More compliance than LLCs: Must follow corporate formalities like payroll, annual meetings, minutes, and separate filings.
- Limited fundraising flexibility: Can’t issue multiple classes of stock, which can make raising venture capital or accommodating complex equity structures difficult.
Best for: Profitable small businesses that want tax efficiency and legal protection.
Example: TechSmith Corporation (maker of Camtasia and Snagit), a privately held S Corp, used the structure to maintain control while enjoying pass-through taxation.
How to choose the legal structure for your business?
The best business legal structures depend on where you’re starting, how you plan to grow, and how much complexity you're willing to take on. If you're wondering which legal structure you should set up, here’s how to choose a legal structure for your business:
Start with liability
If your business involves financial risk, physical products, or legal exposure, lean toward structures that protect your personal assets, like LLCs or corporations. Sole proprietors and general partners carry full personal liability.
Think about taxes
If you’re looking for tax simplicity, pass-through structures (sole proprietorship, partnership, LLC) let you report business income on your personal return. C Corps pay corporate tax separately, which can be good or bad depending on profits and reinvestment needs.
Plan for the long term
If you aim to scale, bring in co-founders, or eventually sell the business, pick a structure that won’t hold you back later. Switching entities mid-way is possible, but can get expensive and complicated.
Note: Many businesses don’t stick with the same legal structure forever. What works when you’re just starting out may need to change as your team grows, your funding needs evolve, or your goals shift.
Here’s a common path we’ve seen and what typically drives each shift:
Factor in funding goals
If you’re planning to raise venture capital, investors often prefer corporations due to their share structure and governance. Sole proprietors and LLCs may struggle to attract equity investment.
Look at operational complexity
Corporations come with more rules: Boards, bylaws, and annual meetings. LLCs and sole proprietorships require less admin. Choose based on how formal or flexible you want the day-to-day to be.
The right legal structure supports your growth. Make sure the one you choose fits both where you are and where you’re going.
Catherine Delcin, a legal expert and entrepreneur, puts it simply: “Getting your business set up to succeed starts with choosing the right legal structure.”
In her appearance on the Home Business Podcast, she breaks down how early structural choices can shape (or limit) a business’s future, from taxes to liability to funding.
Need extra help?
Choosing the proper legal structure can feel like checking boxes until you realize the wrong one could cost you money, flexibility, or funding options later.
At PlanGrowLab, we help early-stage founders and small business owners figure this out without the complexities of legal jargon. No matter whether you're still choosing between having an LLC or an S Corp, or you're handling a business plan writing to complement your structure, we've assisted hundreds of businesses in getting it right on day one.
If you'd rather have professional eyes on your setup or just want to run it by us before submitting anything, we're here. Let us help you ensure your business is built on the right things.
Frequently Asked Questions
How does choosing a business structure affect taxes?
It determines how profits are taxed, whether they pass through to your personal return or get taxed at the business level. It also affects eligibility for deductions and self-employment tax treatment.
Can I change my business structure later?
Yes, you can switch structures as your business grows. Remember, it may involve legal paperwork, fees, and potential tax consequences.
Which is better, LLP or sole proprietorship?
An LLP offers liability protection and shared control, while a sole proprietorship is simpler but riskier. LLP is usually better if you're working with partners.
What is the best type of business ownership?
There’s no single “best.” It depends on your goals, risk level, funding plans, and how much complexity you’re willing to manage.
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