What is a Company?

How a company works

A company is a separate entity to the person, or people, who own it. Companies produce goods, or provide services, usually for profit. They do this by charging customers to consume their products, at a rate higher than the cost of production.

A company can be run by just one person, or have many employees. It can also be called a business.

Different types of companies have different company structures. Company structures dictate how they are run and the responsibilities of their owners.

Public and private companies

Companies can either be public or private. A public company is one that issues shares on the stock market. Shares can be bought by anyone, and the owners of shares all have a say in the way the company is run. A private company is owned by an individual, or a group.

Not all types of companies can be publicly owned, but all can be owned privately.

Whether a company is public or private affects the regulations they are subject to, particularly when it comes to reporting and disclosure requirements. Click here to find out more about public and private companies.

Types of companies

There are many different company types, though most fall into a few main categories.

Sole proprietorship

Perhaps the simplest type of company. Sole proprietorships are owned and run by one person, who is often the founder of the business. A sole proprietorship is easy to set up and has the advantage of affording the owner complete control over it. They may have employees working for the business, or may be completely operated by the one owner.

The owner of a sole proprietorship must calculate the amount of self-employment tax the business pays. This can also involve estimating future tax payments in some circumstances. While tax estimates can be paid quarterly, the company’s earnings are taxed once a year, unlike some other types of businesses.

The main disadvantage to a sole proprietorship is there is no legal distinction between the owner, and the company itself. This means owners are personally liable for the company, and may be required to use their own personal assets to cover business debts or liabilities.

Partnership

A partnership is owned and operated by two or more people. The owners share responsibilities and profits between them, though this share may not always be equal. A partnership can either be general or limited.

A general partnership is owned and operated by the partners, who are themselves responsible for managing the company’s finances. A limited partnership includes general partners and limited partners. The limited partners are investors in the company, but have no control over the way it is run, and are not personally responsible for the company’s liabilities.

A partnership doesn’t pay any tax on its profits. Instead, it passes any profits or losses through to its partners, who then pay personal income tax. If the partnership makes a loss, partners can offset other income against that loss at tax time.

Like sole proprietors, partners are personally responsible for the finances of the business if it gets into trouble. They have the benefit of sharing responsibility for the business across multiple people, but are more expensive to set up. They require a partnership agreement at the outset, which dictates the responsibilities of each partner to the company.

Corporation

A corporation is a complex company type. It has the same legal rights as a person, and is distinguished from its owners, who cannot be held personally responsible for its liabilities. This means that owners’ personal assets are not at risk.

Owners of a corporation have the disadvantage of paying tax twice on profits. A corporation’s earnings are taxed, and any profits that are passed onto owners are also subject to personal income tax. This can be offset by paying owners a salary, which is categorized as a non-taxable business expense, so long as that salary is reasonable.

A corporation is more expensive to set up than a sole proprietorship or partnership. An attorney will need to ensure the corporation is set up in accordance with local laws. It is also more expensive to run, and is subject to more regulations.

Limited Liability Company

A Limited Liability Company, or LLC, is a hybrid company type that combines some of the best features of partnerships and corporations. LLC’s are designed to make it easier to start small businesses, and have become increasingly popular among entrepreneurs.

As the name suggests, the owners of an LLC have much less liability for the company. Owners are not personally responsible for the company, and have the businesses earnings and losses passed through to them to declare on their personal tax returns. In this way, owners avoid the double taxation that corporation owners pay.

A spin-off from LLC’s are Limited Liability Partnerships (LLP’s). Partners in an LLP have the advantage of only being personally responsible for things they have direct control over. For example, if two dentists enter into an LLP, one dentist cannot be held responsible for the malpractice of the other.

Nonprofit

A nonprofit, or not-for-profit, organization exists to provide social good, not to make money. Nonprofits do not pay any tax due to the charitable nature of their work, and are typically funded by donations.

Nonprofits must be government-registered in order to gain their tax exemption, and any money they make is kept within the company itself. Profits cannot be distributed to owners, and are often used to help to expand the company’s operations.