Small businesses play an important role in communities by offering products and services that meet specific needs. The way a small business is set up affects how it operates, who owns it, and who is responsible for it. Knowing the different types of small businesses can help you choose the right setup for your goals. In this article, we explain what a small business is and explore the seven common types.
What is a small business?
A small business is a company that is privately or independently owned and usually has fewer employees or lower revenue compared to others in the same industry. In general, a business with fewer than 500 employees is considered small. Because small businesses often earn less than large companies, they may qualify for more government support. Local small businesses can also offer products or services that meet the specific needs of their community. In many cases, they also build partnerships or support local events and causes.
7 Types of Small Businesses
The structure of a small business is important because it affects how the business runs, how taxes are handled, and who is legally responsible. Before starting a small business, it’s important to understand the different types and decide which structure fits your needs and meets your state’s rules.
1. Sole Proprietorship
A sole proprietorship is a small business owned by one person. This person is responsible for all parts of the business, including debts and legal issues. There is no legal separation between the owner’s personal assets and business assets, so taxes are filed as part of their personal return. Business losses can often be used to reduce the amount of tax owed.
In many cases, the owner is also the only worker in the business. Depending on state laws, the business may not need to be officially registered. Freelancers like writers, designers, or consultants often use this structure if they run the business on their own.
2. General Partnership
A general partnership is run by two or more people who share the responsibilities of the business. These partners are equally responsible for the financial and legal matters, though they may earn different amounts depending on their agreement. Like sole proprietors, general partners can report business losses on their personal tax returns.
They also pay self-employment taxes and include the business income on their own tax forms. This type of setup often works well for people in the same profession, like doctors, lawyers, or software developers. Having more than one owner can also make it easier to get a business loan, since more credit lines are available.
3. Limited Partnership (LP)
A limited partnership also involves two or more owners, but it separates responsibilities between general partners and limited partners. General partners are involved in daily operations and carry full responsibility for the business. Limited partners, on the other hand, invest in the business but are not involved in running it or in most legal matters.
This type of setup allows investors to be part of the business without being responsible for its risks. Since limited partners are not active in operations, they often pay less in taxes. This structure is helpful for medical or legal practices where it’s important to limit responsibility for mistakes to specific people, not the whole business.
4. Limited Liability Company (LLC)
An LLC is a type of small business where the owners are not personally responsible for the company’s debts or legal problems. One or more people can own an LLC, and the business is separate from the owner’s personal property. Forming an LLC may require state fees, which could be paid every one or two years.
Owners of LLCs can choose to report business income on their personal tax forms or file separate business tax returns. They also pay self-employment taxes. Owners don’t have to split profits or losses equally, and the structure can offer either general or limited partnership setups while still giving the legal protections of a corporation.
5. Non-Profit
A non-profit small business earns money to support its mission rather than to make a profit. These businesses usually focus on public service or community programs and rely on donations or funding from supporters to cover costs and grow. Examples include charities or community support groups.
Since they do not aim to make a profit, non-profits can apply for tax exemptions and government aid. To keep their tax-exempt status, they must follow strict rules and keep clear financial records to show how money is used for their mission.
6. C Corporation
A C corporation is a legal setup where the business is separate from its owners, who are not personally responsible for business debts or issues. This structure allows the business to file taxes as a corporation, which can offer certain tax benefits. However, owners may have to pay taxes twice—once for the corporation and once for their own income from the business.
Owners of a C corporation may pay lower self-employment taxes and have access to more tax deductions. This structure is often used by businesses planning to grow or bring in investors.
7. S Corporation
An S corporation is like a C corporation in that it protects the owners from personal liability, but it is limited to one to one hundred owners who must be U.S. citizens. The main advantage is that the business income is passed through to the owners’ personal tax returns, which avoids double taxation on dividends.
This structure helps owners enjoy the legal protections of a corporation while reporting income through their personal taxes. It’s a popular choice for small businesses that want to avoid some of the tax rules that apply to C corporations.
