Building a successful business doesn’t mean following the mold, it means building something that really fits you!
When you’re beginning to organize your new Education Service Provider (ESP) business, you’ll have to make an important decision about its structure. We’re happy to give you insight as you’re making this decision, but we recommend that you find a tax expert to review your decisions and give you pointed advice.
Here are your business-type options:
Sole proprietorship
If you own an unincorporated business by yourself, you’re a sole proprietor. This type of business is simple to start and it keeps you in absolute control. If you’re conducting business without registering a specific type of business, you’re running your business as a sole proprietorship.
With that level of control and because your business isn’t a separate entity, your business and personal assets and liabilities aren’t legally separated. You’re personally liable for any debts and obligations you enter into as a sole proprietor. Funding your business as a sole proprietor can be frustrating — you cannot sell stocks in your business and you’ll find most banks are reluctant to lend to sole proprietorships.
Starting out as a sole proprietor doesn’t mean you’re committed to the business type long term. Sole proprietor ESPs can be the right fit for your business if you’re aiming to start a low-risk, low-complexity business or test out your core idea before filing for a different business type.
General partnership
Like a sole proprietorship, a general partnership is generally simple to start up and wind down, and it isn’t a separate entity from its owners. In a general partnership, each owner shares in the profits and losses of their business. General partnerships are very common — any two or more people that conduct unincorporated business together for profit is a general partnership by default. Like sole proprietorships, general partnerships report their income and losses for taxes through each partner’s personal filings. General partnerships don’t pay corporate taxes.
Though they’re common, simple, and have proven themselves to work, general partnerships come with a couple significant drawbacks. Like a sole proprietorship, each owner is personally responsible for any liabilities the business takes on. Courts can put a lien on your personal assets should you fail to uphold your business debts and obligations with business assets.
Take special consideration with whom you go into a general partnership. Each partner is responsible for each contract into which any other partner enters. Just as much as you may benefit from your partner’s successes, you may end up paying for your partner’s failures.
Partners should have a clear understanding of the potential business they’re going to run as a partnership. Partners, furthermore, should understand each others’ loyalties to prevent any conflicts of interests, and disclose their business activities, contracts, and finances. If there is a significant discrepancy between the assets and liabilities of partners, you’ll understand up front who has the most to lose should things go poorly for your company.
For the above reasons, banks are hesitant to provide loans for general partnerships. Furthermore, because all owners must also be involved in the operations and management of the business, investors can’t buy stocks in general partnerships. General partnerships, however, can be an attractive option for new businesses when it allows partners to employ their specialized skills and pool their financial resources.
If you form a general partnership, draft up a partnership agreement that outlines what happens when one partner passes, is unable to fulfill their responsibilities, or wants to leave the partnership.
Limited partnerships
A limited partnership is the first business-type on this list that requires the business be registered with the state’s licensing authority — the Arizona Corporation Commission (ACC). A limited partnership is owned by general partners and limited partners. General partners in a limited partnership function identically to partners in a general partnership — full liability for other general partners, requirement to be engaged in the running of the business, and filing taxes and income personally. Limited partners, on the other hand, are only liable up to the amount they contribute to the business, may not be personally involved in the decision-making of the business, and share in the profits from the business.
Limited partnerships allow general partners to attract funds from investors. Investors as limited partners have limited liability and limited engagement.
If you form a limited partnership, you must draft up a partnership agreement that outlines what happens when one partner passes, is unable to fulfill their responsibilities, or wants to leave the partnership. State laws have special regulations and requirements for limited partnerships that general partnerships and sole proprietorships do not.
Limited liability partnership
Limited liability partnerships (LLP) are like general partnerships where each partner shares some liability for the contractual debts of the partnership. Partners in a LLP, unlike a general partnership, are not liable for non-contractual liabilities and damages other partners cause.
LLPs have a more flexible partnership structure than general partnerships. Other than concerns involving change to partners (which require all partners to approve), LLPs may assign specific responsibilities and controls to each partner unevenly.
LLPs allow partners to have limited liability up to their contribution amount while being involved in the management of the business. Courts may waive limited liability on a case-by-case basis dependent on state law for serious misconduct or fraud. While you’re better protected as a partner in a LLP than a general partnership, you’re still responsible with whom you do business.
Limited liability company
A limited liability company (LLC) is a great choice for an organization structure. Many businesses elect to incorporate as an LLC because it allows owners (called members) limited personal liability for the debts and obligations of the company. LLCs can flexibly organize and utilize its members and managers.
An LLC begins when an organizer or its members or managers (depending on management structure) submit articles of organization to the ACC. An organizer can be, though not necessarily, a member or manager of the LLC.
LLCs may have a single member or more. Members are owners and can function either as shareholders, board members, or officers. A member may also be a manager. If an LLC is managed by members and each member has voting rights, that LLC will operate much like a partnership. Alternatively, if an LLC is managed by non-members (manager-managed), that LLC will behave like a corporation where the board of directors, shareholders, or officers make decisions but don’t participate in operations. The ACC will ask for your management structure and will only allow paperwork afterwards from members if member-managed or managers if manager-managed going forward.
If you want to be non-profit, you may apply for non-profit status with the IRS after forming an LLC with Arizona. The IRS considers your articles of organization when assessing your nonprofit status. So, you’ll need to incorporate with or amend your articles of organization with nonprofit-friendly language if you want to pursue this route.
Though the ACC doesn’t require LLCs to submit an operating agreement, these documents are instrumental for guiding the LLC’s relationship between members and managers.
Corporation
Forming a corporation isn’t for the faint of heart nor should it be done unless raising capital and a complex structure is integral to your business plan. A corporation, unlike any of the above business organization types, is a completely separate entity from its owners. Limited liability is built into the structure of a corporation. Corporations have a life of their own and are limited to the scope of their corporate charter. Further, corporations’ profits and dividends are taxed. Arizona has a competitive corporate tax (4.9% flat), but new business owners may want to pick a structure with pass-through taxation like the organizations above.
The law has high-demands on corporations other business organizations don’t have to manage. Extensive regulation and record-keeping requirements will be a part of the regular life of a corporation.
Non-profit corporation
Arizona requires non-profit corporations to incorporate with the ACC. Multiple types of non-profit organizations exist, but businesses must apply for tax-exempt status with the IRS, not the state. The IRS typically awards tax-exempt status for corporations that are charitable, religious, educational, scientific, literary, testing for public safety, fostering amateur sports competition, or preventing cruelty to children or animals. Nonprofits like other corporations may tailor their organization structure to fit their needs, but have legal requirements on ownership and structure that reflect the organization’s unique entity status. Please note: You can set up your business in Arizona as a non-profit corporation first, and then apply for your IRS 501(c)(3) status. This is quite common as the IRS process does shift in the time it takes for your approval.