What is Business Structure?
Business Structure refers to the type of set up that an investor wants to put in before starting a business and it primary depends on the type of business set up, liability assumed and tax incentives.
Business Structure Types
#1 – Sole Proprietorship
- When an individual owns the business completely then they may go for a sole proprietorship structure. In this structure, the business is not a separate legal entity. So the profit generated from the business is clubbed with the individual’s personal incomePersonal IncomePersonal income refers to the total earnings of the individuals and households of a nation through multiple sources such as salary, wages, business profits, bonus, investment returns, dividends, rental receipts, employer contribution in provident or pension funds, etc. and taxed accordingly.
- The advantage here is that if you have made a loss in the business and in other sources you made a profit, then the loss will be able to reduce the taxable income and you will be able to enjoy tax shieldTax ShieldTax shield is the reduction in the taxable income by way of claiming the deduction allowed for the certain expense such as depreciation on the assets, interest on the debts etc. It is calculated by multiplying the deductible expense for the current year with the rate of taxation as applicable to the concerned person.. This is a great advantage. Having said that, as the business and the person is not a separate entity.
- So the creditors of the business turn out to be the creditor of the owner and any claim that will not be met from the asset of the business will then be recovered from the owner’s personal assets.
- So any legal proceedings done towards business will affect the owner directly and his personal properties. Raising funding for Sole proprietorship is also tough as the institutions don’t get the confidence to lend money. Default riskDefault RiskDefault risk is a form of risk that measures the likelihood of not fulfilling obligations, such as principal or interest repayment, and is determined mathematically based on prior commitments, financial conditions, market conditions, liquidity position, and current obligations, among other factors. is always high in Sole proprietorship.
#2 – Partnership
Partnership structure is adopted when there are several investors to the business. There are mainly two types of partnership structures:
1) General Partnership
General Partnership structure there are several owners of the business and each owner is actively taking part in the business. All decision about growth, expansion, and sustainability is being taken collectively by all. So the liability of the business is also shared between all the partners.
2) Limited Partnership
- Limited PartnershipLimited PartnershipIn a limited partnership, two or more individuals form an entity to undertake business activities and share profits. At least one person acts as a general partner against one limited partner who will have limited liability enjoying the benefits of less stringent tax laws. structure comprises both limited and general partners. General partners are the decision-makers and limited partners act like investors. They are not part of the decision committee. So limited partners don’t have any liability towards the business and the only risk they have is the risk of their capital.
- Partnership structure is more time consuming that Sole proprietorship because lots of legal works are involved and it is costly to set. There is an advantage to the partnership structure. No tax is charged at the partnership level, which means the business doesn’t pay any tax, so the profits are distributed to partners and they pay tax at a personal level. There is no double taxationDouble TaxationDouble Taxation is a situation wherein a tax is levied twice on the same source of income. It usually occurs when the same income is taxed both at corporate as well as at the individual level. that is tax once charged at a business level and also a personal level.
#3 – Corporation
- The corporation is the most complex business structure. This is how most of the large organizations are formed. The most important feature of a corporation is that the entity and owners are separate. This restricts the claim of creditors to the business itself. So the owner’s personal assets will not be at risk if the business fails.
- A corporation can issue shares, both common shares, and preferred shares. The corporation doesn’t have a maturity, it is a separate entity and lasts forever. If a shareholder dies, then the shares can be transferred to others.
- Corporations are really costly to set-up as they are listed in exchanges and require lots of legal works such as the formation of the board, selecting underwriters, and other set-ups.
- The disclosure requirement incorporation is too high, so the risk of idea leakage is immense.
- The most important drawback of a corporation is double taxation. Corporate Tax is charged to the organization separately and when dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity. are being distributed to shareholders, a dividend tax is also charged. So this creates a huge impact on the personal income of the owners.
- Fundraising is extremely easy for a corporation as there are several sources by which a corporation can raise funds and Institutions gain confidence in financing corporations as they are structurally big and meets legal obligations before setup.
Features of Business Structure
- It should be simple so that participants get to know what is happening and the chances of fraud reduce. A simple structure attracts individuals who research companies and plan to invest. So it should be transparent and simple.
- Ethics should be strong, there should be clear rules circulated within the organization regarding correct procedures to be followed
- The Hierarchy shouldn’t be too complicated. There should always be a way by which employees can reach the Top Management.
- There shouldn’t be too much difference in the pay structures of regular employees and higher management.
- Good care of employees should be taken. A good organization is known for its behavior towards employees.
- Adaptability is the key. A good business structure should be open to changes. It should be able to adapt to changing environments.
- Business structures are decided based on the need that is put forward by the owner. Each structure has separate advantages and disadvantages which should be kept in mind before choosing. There is not a single best structure that an owner may choose.
- When an owner starts alone, then he may start as Sole proprietorship and slowly move to the partnership. There are several businesses running in the world which are registered under different structures and serving different needs.
This has been a guide to What is Business Structure & its Definition. Here we discuss the types of business structures with detailed explanations and their features. You can learn more about from the following articles –