Coming up with a new business idea is such an exciting moment.
But there’s always one question that follows…
“What do I do now?”
You have a vague intuition that you need to register your business in order to start building it but have no idea what type of business you need to register as.
That’s where this guide comes in.
I get that talking about law and accounting is not exciting, so I’ve kept it concise and in plain English that everyone can understand.
I’ve broken it down into 2 main parts:
- A general overview of business types that most countries have
- Separate sections for the United States, United Kingdom, and Canada that highlight specifics to those regions.
Before we dive in, it’s time for a standard disclaimer. While all of this is researched to the best of my ability, I am not a lawyer and this is not legal advice. Use this post to get a solid quick overview, and then consult a lawyer if you have more specific questions or concerns.
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The 3 Types of Businesses That Most Countries Have
Your business options vary depending on which country you live in.
However, most countries share the same 3 main business types:
- sole proprietorship
While they differ in subtle ways in different countries, the core concepts and functions are the same.
Once you understand them, we can move onto country-specific business types.
The simplest type of business is a sole proprietorship, which technically isn’t even a legal entity. Your business is tied to your identity as a person.
In simple terms, this means that the business isn’t seen as anything that can assume legal liability. Therefore, all legal and tax consequences fall squarely on you.
If the business gets into a lot of debt, you’re personally responsible for paying those back. You will be taken to court for those debts.
You can still call your sole proprietorship something other than your personal name, but your name will be on checks and any other financial transactions for the business.
Why a Sole Proprietorship might be right for you:
- No formal registration is usually needed. You can form one instantly in your living room
- There are no formalities like agreements or bylaws
- You can transfer money between your personal accounts and business as much as you’d like.
Why a Sole Proprietorship might be wrong for you:
- Taking on all liability is risky, especially if you already have a large amount of wealth to being with (more to lose)
- You can’t sell shares or equity in your business
- In the hopefully unlikely situation that you die, the business will likely die as well.
As the name implies, a partnership is when 2 or more people come together and agree to run a business together.
Partnerships are essentially a middle ground between a sole proprietorship and corporation.
In most countries (depending on state/ province) you’ll need to create a basic partnership agreement, but a handshake can be enough to formalize the partnership. You should have an attorney help you draft the agreement, which usually costs less than $2,000.
There are actually 3 common sub-types of partnerships. Here’s a brief overview of each:
- General partnership: The most basic partnership. You do need to get business licenses, but you do not need to file your business with the government. It’s cheaper and faster to get going, but you both share liability.
- Limited partnership: A limited partnership has one or more partners, called “general partners,” that assume all the liability (they are responsible for debts). The other partners are called “limited” partners.
- Limited liability partnership: Similar to limited partnerships, but only certain businesses can form them, like doctors, lawyers, accountants, dentists, and other professions depending on your specific location.
Regardless of the type of partnership that you’re after, you’ll want to see a lawyer to create the partnership agreement and nail down the specifics.
Why a Partnership might be right for you:
- Relatively cheap and fast to form compared to corporations
- Few formalities are required (e.g. meetings and agreements)
- There is no minimum amount of taxes that you are required to pay (unlike LLCs and corporations).
Why a Partnership might be wrong for you:
- If the business accrues debt, you may be liable to pay it (depending on the partnership structure)
- A lot of trust is involved between partners; personal disputes can cause the business to crumble
- You may have to take responsibility for not only your actions, but of partners as well.
When you think of a typical business, you probably think of a corporation.
There are a few specific types that we’ll get into, but let’s get a general overview of what a corporation is first.
The biggest defining factor of a corporation is that it’s seen as a “person” in terms of legality. It can be on both sides of a lawsuit, can purchase or sell property, and is taxed.
Compared to sole proprietorships and partnerships, corporations protect their owners from liability (there are a few exceptions).
Why a Corporation might be right for you:
- Your personal assets are protected from company debts
- You can sell off shares or equity of the business
- Corporations can continue to operate, with or without you
- In some situations, certain types of corporations come with tax benefits.
Why a Corporation might be wrong for you:
- More formalities are required, both upfront and ongoing; for example, in most states(in the U.S.), corporations have to have annual meetings with recorded minutes
- Decisions must be made by the board of directors, which can delay them.
- They are more expensive to set-up and also require annual fees.
A final important note about corporations is that they can be either public or private:
- Public companies are the businesses listed on the stock exchange that have sold shares. These companies need to comply with their national securities and exchange commission, which involves a lot of extra regulation.
- Private companies are what business are when they first become a corporation. The vast majority (over 99%) of businesses are private, and will always stay private. If you need to go public, your business will already have a team of lawyers ready to handle it.
Business Types in the United States
The 3 business types above all exist in the United States, plus one bonus type (the LLC) that I’ll explain shortly.
I’ve provided the most useful links for each business type below.
Sole Proprietorships and Partnerships in the United States
There’s nothing out of the ordinary about sole proprietorships and partnerships in the U.S.
All 3 sub-types of partnerships that we looked at are available.
There’s no formal business registration required. The only thing you have to do is file extra tax forms:
If you have employees, you will need to apply for an Employer Identification Number (EID).
Corporations in the United States
The standard corporation in the U.S. is called a “C” corporation (c-corp).
Alternatively, you can register as an “S” corporation (s-corp). To do so, you first register as a c-corp, and then fill out Form 2553.
Both types of corporations remove your liability from the business, which is the main purpose.
The main difference is when it comes to paying tax. S-corps don’t pay corporate income tax. Instead, the business income or loss is passed onto the owners of the business.
Basically, s-corps can help you avoid double-taxation. You’ll need to consult a lawyer and accountant for your specific business to see whether or not it’s worth converting.
On top of tax differences, there are some other requirements you have to meet in order to be allowed to become an s-corp. For example, shareholders have to be U.S. citizens (or resident aliens), and there is a maximum number of shareholders that you can have.
Limited Liability Companies (LLCs) in the United States
The LLC is the United State’s version of a private limited company.
It’s a much newer concept than standard corporations. Most states only passed LLCs into law in the 1980s and 1990s.
An LLC is essentially a middle ground between partnerships and corporations in terms of ease of administration and how you deal with tax and liability.
A big issue that many people have with corporations is that they still have laws and rules in place from hundreds of years ago. That’s why there’s a lot of bureaucracy that seems unnecessary and time wasting.
An LLC removes a lot of that formality. It’s simpler to get started and carry on with than a corporation. Yet LLCs still offer limited liability that protects your personal assets.
Another defining feature of LLCs is the flexibility they offer. They can also be structured and taxes like sole proprietorships, partnerships, or corporations (C or S).
Your taxes are typically paid based on the number of members (founders or partners). If it’s just you, you’ll pay taxes like a sole proprietorship. If it’s multiple partners, you’ll pay taxes just like a partnership.
As your business grows, you can always transition into a corporation if it offers significant tax advantages.
Why an LLC might be right for you:
- It’s quicker than a corporation to setup and offers liability protection
- Fewer formalities than corporations
- Lots of flexibility in how you structure your business
- Taxes often end up lower than corporations if you’re running a small business.
Why an LLC might be wrong for you:
- LLCs do not scale well. If your business grows fast, you’ll end up converting to a corporation
- While cheap in the long run, they are more expensive to set up than sole proprietorships or partnerships
- They require annual fees in most states
- While you can raise money with LLCs, it’s more complicated for investors and can scare them off.
Business Types in Canada
It shouldn’t be a surprise that Canada operates very similarly to its neighbor, the United States.
Sole Proprietorships and Partnerships in Canada
You can operate a sole proprietorship or any one of the three partnership options in Canada. Their definitions are near-identical to their U.S. counterparts.
You will need to start by finding out the permits and licenses that you will need to operate your business.
Next, you will need to register your business in any case with your province.
- British Columbia
- New Brunswick
- Northwest Territories
- Nova Scotia
- Prince Edward Island
Corporations in Canada
In Canada, you can incorporate at either the provincial or federal level, depending mostly on where you plan to do business.
Corporations in Canada closely align to the definition of corporations we looked at earlier. There are still formalities and regulations to be followed, and fees to be paid.
The government website has a great step-by-step guide to registering your business as a corporation.
Cooperatives in Canada
This is an uncommon type of business, but still an option.
A cooperative is a business owned and operated by a group of members. Even though it functions a lot like a partnership, it offers limited liability to members.
Cooperatives are operated democratically, meaning that all members get to vote on how the business is run. Profits are distributed according to members according to their contributions to the business.
There is more record keeping needed, and voting can make business decisions take longer (or get stalled).
It’s a good business model for groups of workers that all want to accomplish a similar goal together.
Business Types in the United Kingdom
The United Kingdom operates similarly to the U.S. and Canada, and really only supports the 3 main types of businesses.
Sole Proprietorships and Partnerships in the United Kingdom
In the United Kingdom, sole proprietorships go under the term sole trader.
Other than the name change, they are nearly identical.
Again, nothing formal needs to be submitted to become a sole trader. The only difference is that you need to complete self-assessment taxes and pay National Insurance (Class 2) as soon as you begin.
As for partnerships, all three sub-types exist, although limited liability partnerships were not established until 2000.
Corporations in the United Kingdom
Corporations in the U.K. are called limited companies.
A limited company is its own legal entity, which shields you from liability. They follow all the same core concepts of corporations we looked at above.
Limited companies can be either private or public. Public companies must follow extra reporting requirements as usual (from the SEC).
The government website has a simple guide to registering as a corporation.
Final Words of Advice
Unless you’re positive that you want to operate as a sole proprietorship (or sole trader), it’s always a good idea to consult a lawyer.
While few start-ups want to spend time and money on a lawyer, it can save you a lot more in the long run on taxes. And you probably won’t have to convert to a different business structure later on.
The information provided here is a general guide to the rules in each country. Seek personal advice before going ahead with your venture.