Deciding how your business is going to be structured depends a lot on what type of business you want to open, how many people are already invested in your business idea, and where you're getting your loans from. Choosing the right type of business is important, though, because it will affect you when it comes time to file taxes, borrow money, or attract investors. Your ownership structure can also alter the outcome in the unfortunate event that your business needs to deal with a lawsuit. Below, we break down the types of ownership structures and their pros and cons to help you decide which option is best for your business.
Types of Business Ownerships
There are many different ways that you can organize your business and the ownership structure, but not every type is viable for the foodservice industry. Here are six different types of business structures that you can use when setting up your restaurant.
Sole Proprietorships
Sole proprietorship is one of the most popular business types in the foodservice industry, and it's when a business is owned by a single individual. Sole proprietorship has a simple structure, and it's common among small restaurants and family-owned businesses.
Pros of Sole Proprietorship
Here are some of the benefits of setting your business up for sole proprietorship.
- Sole proprietorship is the easiest and most inexpensive structure to establish.
- The sole owner has complete control over the business, so they can make any changes or decisions at their discretion.
- The business is taxed as part of the owner's personal taxes, so there's no need to file taxes twice.
Cons of Sole Proprietorship
While there are many benefits to sole ownership of a business, there are several cons as well.
- There is no legal separation between the owner and their business, so they can be held personally liable for all debts and obligations incurred by the business. This means that debt collectors can repossess the owner's house and belongings if they were to default on their debt.
- It's harder to get funding from investors for a sole proprietorship.
- While sole proprietorship means one person has complete control over the business, they also have the most responsibility, which is stressful.
Partnerships
Partnerships involve two or more individuals who own the business together. Each partner contributes to the business through money or expertise or connections and shares profits and losses. Similar to sole proprietorships, the business isn't a separate entity, and the owners file the business's taxes when doing their personal taxes.
Pros of Partnerships
Here are some benefits to structuring your restaurant in a partnership.
- Partnerships are very inexpensive and easy to form.
- Partners share finances, and each individual invests in the success of the business, relieving some of the personal burden that is present in sole proprietorship.
- Usually, partners bring different skills and areas of expertise to the business, such as business expertise, a background as a chef, or marketing skills.
Cons of Partnerships
Partnerships are a beneficial ownership structure, but there are some downsides as well.
- Similar to sole proprietorships, there is no legal separation between the business and the partners, so there is a lot of personal liability if the business fails or goes into debt.
- Disagreements between different partners can make it difficult to come to agreements and make decisions concerning the business.
- Since partnerships are jointly owned, each partner has to share the profits from the business. As a result, each partner will make less money than if they owned the business solely.
Cooperatives
Cooperatives, also known as co-ops, are businesses that are formed when multiple people with similar professional goals decide to start a business. Cooperatives do not have one single owner, instead each member owns a portion of the business, and, as a result, each member has a say in how the business is run. Because of the ownership structure, cooperatives are more collaborative than other types of businesses. Cooperative business structures are common in food production, farmers markets, or grocery stores, and less common in traditional foodservice businesses.
Pros of Cooperatives
There are some benefits to structuring your restaurant or foodservice business as a cooperative.
- Cooperatives are not taxed on surplus earnings that are refunded to members, so there's less of a tax burden on members.
- There are many government-sponsored programs that provide grants to cooperatives to help them get started.
- It's easier for cooperatives to receive discounts on supplies, materials, and services than other business types.
Cons of Cooperatives
Here are some of the downsides of opening a cooperative.
- Success depends on member's involvement and cooperation.
- As a result, cooperatives can suffer from slower cash flow since a member's incentive to contribute depends on how much they use the cooperative's services and products.
- Lack of participation from members can cause the business to decline.
Limited Liability Corporations (LLC)
A limited liability corporation, or an LLC, is a legal structure that combines the benefits of a corporation and a partnership. One of the main benefits of an LLC is that the business is an independent entity. As a result, they have the limited personal liability features of a corporation and the tax efficiencies and operational flexibilities of a partnership. But, LLCs can be time consuming and difficult to set up, so they're not optimal for small restaurants and businesses. Instead, they're more common for large chains and establishments with multiple franchises.
Pros of Limited Liability Corporations
Here are some of the benefits of opening an LLC.
- Members are protected from personal liability for any business decisions or debts that are incurred.
- There is less record-keeping and paperwork involved, and fewer startup costs are required.
- There are fewer restrictions on profit sharing in an LLC, and members can distribute profits from the business as they see fit.
Cons of Limited Liability Corporations
While LLCs offer limited personal liability and many freedoms, there are some downsides as well.
- Oftentimes, when a member leaves an LLC, the business dissolves and the remaining members are left with the burden of fulfilling all remaining obligations to close the business.
- Members are considered self-employed and must pay the self-employment tax contributions.
- The entire net income of the LLC is subject to the self-employment tax.
C Corporations
A C corporation is an independent entity that is taxed separately from its owners. This type of business is made up of different shareholders which are given stock when they invest. This type of ownership structure typically isn't viable if you're just opening one restaurant location due to the amount of effort, paperwork, and money that's involved. Additionally, according to regulations, C corporations must have assets of $10 million or more, which is unlikely for new restaurants.
Pros of C Corporations
If you're planning on starting a large restaurant chain, a C corporation may be the best type of business for you. Here are some benefits to using this ownership structure.
- The corporation acts as a separate entity, so shareholder's personal assets are protected from any of the business's debts or legal actions.
- Corporations can easily raise funds through the sale of stocks.
- Taxes can be filed separately from the personal taxes of the corporation's owners.
Cons of C Corporations
While this business type might work for large organizations, they are not the best choice for every type of foodservice establishment. Here are some cons of starting C corporations.
- Corporations are costly and time-consuming to start and operate.
- Sometimes, corporations can be taxed twice. Once when the company makes a profit, and again when dividends are paid to stockholders.
- There is additional paperwork to fill out because corporations are highly regulated by federal, state, and local agencies.
S Corporations
An S corporation is similar to a C corporation, but it has to file additional tax forms with the IRS before they get set up. S corporations also choose to pass corporate income, losses, deductions, and credits to their shareholders, which impacts the shareholder's federal taxes. The shareholders then report the income flow and recieve a tax assessment based on their individual income. Generally, a local business will not want to choose this option as it's meant for larger business models.
Pros of S Corporations
If you run a large foodservice organization, there are many benefits to operating an S corporation.
- Unlike a C corporation, taxes in an S corporation are only paid at the individual level and not at the corporate level, which eliminates the chances of double taxation.
- Some expenditures that the business incurs can be written off as business expenses.
- Owners of an S corporation can have an independent life separate from their shareholders, allowing them to leave the company without disturbing business operations.
Cons of S Corporations
Here are some potential downsides of starting an S corporation.
- Since an S corporation is a separate structure, you need to hold director and shareholder meetings regularly.
- There are strict compensation requirements in place for shareholders.
- S corporations have a risk of paying higher employment taxes than other types of businesses.
The type of business that is best for your restaurant depends on which how large you expect your business will be. For example, small mom and pop restaurants are probably best as sole proprietorships or partnerships. But, if your restaurant starts becoming popular and you're considering expanding and opening multiple locations, filing paperwork to become an LLC or corporation may be a worthwhile option.
