Types of Business Entities: How They Work & How to Choose One

According to Guidant Financial’s 2025 report, 28% of small business owners say they started their business to be their own boss. However, starting a business takes more than just motivation.

One of the first real decisions is choosing from the different types of business entities, which will determine your taxes, personal risk, and how your business runs.

As such, this guide will discuss the different types of business entities, how they work, and what to consider when choosing one to ensure you’ll establish a structure that makes sense with your goals.

What Are Business Entities?

A business entity is the legal setup a person or group chooses when starting a business. It defines how the business exists under the law.

This structure affects how the government recognizes your business, how it’s taxed, and how it’s held responsible for debts or legal issues.

Depending on the setup, it also separates or connects you from the business.

Every business in the U.S. must operate under some form of legal structure. This step is required when registering the business, applying for licenses, or filing taxes.

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What’s the Difference Between Types of Business Entities?

Types of Business Entities

Below are the most common types of business entities in the United States:

Sole Proprietorship

A sole proprietorship is a business owned and operated by one person, with no legal distinction between you and the business.

You will record all income and expenses on your personal tax return.

However, you are personally liable for business debts and legal claims, putting personal assets at risk.

This structure often works well for freelancers with side hustles, contractors, or anyone running a business alone with low overhead and risk.

Some examples include Sears, Roebuck and Co., A&W, and Kate’s Real Food.

Partnership

A partnership is a business run by two or more people. In this setup, you agree to share the work and split the profits.

The business doesn’t file its own income tax. Instead, each partner reports their share of the profits on their personal return.

This keeps taxes simple, but it also means everyone is personally responsible for their part of the business.

Let’s say you and your partner live a DINK lifestyle – dual income, no kids – and want to invest time and money into a shared side business.

Or maybe you’re empty nesters looking to turn a shared hobby into income. If you trust your partner and want to keep things simple, a partnership could be a practical option.

Examples of partnerships are as follows:

• Uber & Spotify – Music and rideshare collaboration
• Nike & Apple – Fitness product partnership
• GoPro & Red Bull – Extreme sports content collaboration

Limited Liability Company (LLC)

An LLC is a business structure that separates your assets and liabilities, protecting you from legal claims.

LLCs are known for being flexible because you can run one on your own or with others.

This setup is common among small business owners who want legal protection without dealing with too much paperwork or complex rules.

Examples of real-life LLCs include:

• Google – Converted to an LLC in 2017 after Alphabet Inc. restructuring
• Vivo Capital – A healthcare venture capital firm
• General Motors – Automotive manufacturing company
• Bristol-Myers Squibb & Gilead Sciences, LLC – Gilead Sciences Inc. subsidiary

Cooperative

A cooperative is a business owned and run by the people who use its services.

These people are called members, and each one has a say in business management.

Instead of profits going to outside investors, you’ll share the earnings among the members.

Cooperatives are also common in farming, energy, food, housing, and retail.

For instance, you and a group of local business owners want to open a shared grocery store that features local products.

If each of you wants equal input and a portion of the profits based on your involvement, a cooperative structure is ideal.

State Farm, Dairy Farmers of America, Northwestern Mutual, and New York Life are examples of cooperatives.

Corporation

A corporation is a legal structure that separates the business from its owners.

This entity requires formal registration, regular meetings, and detailed records.

In return, it offers strong legal protection and easier access to outside funding through share sales.

If you’re planning to grow fast or bring in outside investors, a corporation could make sense.

Examples of corporations include Amazon, Huawei, Intel, and IBM. Here are the types of corporations you can consider:

C Corp

A C Corp is a type of corporation that’s taxed separately from its owners.

This means the business pays taxes on its profits, and then shareholders pay taxes again on any dividends they receive.

C Corps can have an unlimited number of shareholders and different classes of stock.

This flexibility makes them a common choice for companies planning to grow fast or raise money from outside investors.

S Corp

An S corporation follows special IRS tax rules.

Instead of paying taxes at the corporate level, the business passes its profits directly to the owners, who report their share on their personal tax returns.

S Corps still offers liability protection, which helps separate your personal finances from the business.

However, you can’t have more than 100 shareholders, and everyone must be a U.S. citizen or resident.

Also, the company can only issue one class of stock.

This structure is ideal for businesses that want the legal benefits of a corporation but prefer a simpler tax process.

Close Corporation

A close corporation is owned by a small group of shareholders and does not offer shares to the public.

Ownership is generally limited to people with pre-existing relationships.

This setup lets you manage the company directly without needing a board of directors.

Close corporations still offer legal protection, just like other corporations.

However, they skip some of the more formal requirements, like holding large meetings or dealing with complex reporting rules.

Benefit Corporation

A benefit corporation is a for-profit business that pursues a public or social mission.

This structure is legally required to consider both financial returns and societal impact.

Owners must track and report progress on goals such as sustainability, labor practices, or community benefits. S

ome states also require public benefit reports.

Nonprofit Corporation

A nonprofit corporation serves a public purpose rather than generating profit for owners.

It can apply for tax-exempt status, avoiding federal income tax on donations, grants, and service revenue.

Nonprofits must follow strict state and federal regulations, including regular reporting.

Common focus areas also include education, healthcare, religion, and social services.

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How to Choose the Right Type of Business Entity (Step-by-Step Guide)

The right type of business entity depends on what you’re building, how you plan to grow, and who’s involved.

So, here are the steps to help you choose an appropriate entity for your business.

Step 1: Define Your Business Goals and Needs

Defining your business goals and needs involves the following steps:

Identify Your Growth Plans

Start by outlining how fast you want the business to grow and how broad your reach should be.

The structure you choose needs to support this pacing and direction.

For example, if you plan to grow from a local bakery to a multi-location brand, you’ll need a structure that handles multi-state compliance and growth.

Clarify Your Long-Term Vision

Your exit strategy or legacy plans will influence which entity makes sense.

A structure that supports long-term ownership may not be ideal if you’re planning to sell.

If you aim to build a business that your children can take over, pick an entity that makes ownership transfers straightforward.

This choice is critical for ensuring long-term financial stability, especially if you intend to build a company that lasts for generations.

Evaluate Your Risk Tolerance

Look closely at how much personal exposure you’re willing to accept. Liability rules differ by structure and can directly impact your finances.

If you’re opening a home-based catering business and want to protect your savings from lawsuits, consider a structure like an LLC.

Decide on Management Style

Decide how you want to manage the company and allocate responsibilities.

Certain structures allow complete control, while others distribute authority through formal roles or agreements.

For example, if you’re starting a digital agency and want to run operations without approval from others, a sole proprietorship or single-member LLC gives you that control.

Think About How You’ll Raise Money

Funding is another factor in your choice of entity. Investor-friendly structures often involve more complexity, while simpler options work better if you’re self-funding.

Say you’re building a fintech platform and plan to seek venture capital. Forming a C corporation allows you to issue shares and attract investors.

Understand the Tax Impact

Your structure decides how the IRS taxes your income and how you report it. Weigh how much control you want over that process.

Depending on your income, if you’re self-employed and want to avoid double taxation, you might prefer a sole proprietorship or S corporation.

Step 2: Review and Compare Different Types of Business Entities

To review and compare different types of business identities, follow these steps:

Compare the Options

Create a chart and list the strengths and weaknesses of different types of business entities.

Use categories that directly affect how your business runs, its stages of growth, and what it costs to operate.

For instance, here are the factors you must include:

• Liability protection – Will this structure shield your personal assets if a client, customer, or partner sues your business?
• Tax treatment – How are profits reported and taxed? Can you avoid double taxation?
• Control and decision-making – Does this structure give you full authority, or does it require shared input?
• Ability to raise capital – Can you take on investors, issue stock, or apply for business grants?
• Scalability – Can the structure support growth across state lines or through multiple partners?
• Paperwork and compliance – What are the requirements for yearly compliance? Are there recurring fees or reports?

Choose the Best Fit for Your Current Needs

Pick what works for your current lifestyle and vision, not where you expect to be in five years. Remember that your structure should match your budget, workload, and risk.

Step 3: Talk to Professionals Before Finalizing

The expert guidance you’ll need involves the following professionals:

Legal Help

Talk to a lawyer before you finalize your chosen type of business entity.

They’ll explain the state filing requirements, licensing, permits, dispute resolution, contract terms, and prepare documents that reflect your business operations.

If you’re starting a business with a partner, a lawyer can draft an agreement that outlines each owner’s role, share, and responsibilities.

Tax Advisor

Meet with a tax professional to understand how your business will be taxed under each entity.

They can calculate how much you’ll owe, your deductions, and which structure accommodates your income level.

Accountant

An accountant will help you set up your expense tracking system, payroll records, and business tax documents, and stay on top of reporting requirements.

This makes it easier to track expenditures, file taxes, and avoid penalties.

Step 4: Stay Flexible and Open to Change

Your needs will shift as the business scales and expands. Once the business is running, revisit your structure to check if it still aligns with your objectives.

If it doesn’t, you can convert to a different entity when needed. Most states allow you to update your structure without starting from scratch.

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