Informal Business Structures
Informal business structures; such as, sole proprietorships and partnerships, have minimal to no registration requirements and do not provide separation between the owners of a business and the business itself. Because of this lack of separation, the law sees the owner of the business and the business as one entity. These types of businesses usually start off as hobbies, are very low risk, and are often very small with a small customer base and don’t require or are not planning to obtain outside financing.
The only distinct advantages of informal business structures are that they can be started faster, have lower upfront costs and are simpler and cheaper to operate and maintain.
While fast and cheap may sound good, informal business structures have some serious disadvantages as well. First, and most importantly, they provide no liability protection. This means the personal assets of the owners are at risk if debts can’t be paid or the business is sued. There are zero tax benefits for these types of structures. And due to a lack of credibility and a low potential for outside funding they have very limited growth potential.
Formal Business Structures
In contrast, formal business structures; such as, limited liability companies ( LLC ) and corporations, are more complicated and expensive to start and maintain. But, they have the added value of being seen as a separate entity from the business’ owners. This separation provides owners a level of protection from the business’ liabilities, like bad debt or business related lawsuits.
Greater personal liability protection is usually the primary motivator for implementing a formal business structure. However, these structures also provide tax benefits, make it easier to obtain outside funding and investment, more flexible profit distribution, and provide a structure for managing the business.