What Is a Small Business?

What is a NAICS code?

NAICS (North American Industry Classification System) codes identify types of business activity. Among other things, these codes are used by the Small Business Administration to categorize industry size standards.

How are small business classifications determined?

Numerous factors go into how the SBA determines whether a business is small. In a 2019 report on its methodologies, the SBA notes four primary factors used when assessing size standards:

• Average firm size: How large is the average business in this industry?
• Industry competition: How is market share concentrated within the industry? What size are the businesses that hold most of the market?
• Startup costs and barriers: How much money is needed for a business to become competitive in its given market? What other barriers to success are in place?
• Distribution of firms by size: Is the industry dominated by several large businesses? Are small businesses competitive in this industry?

Every five years, the SBA reviews size standards and potentially revises them. Public comments are considered during this review period.

Why does a small business classification matter?

Small business classification matters for certain loans and if you plan to contract with the federal government. Some loans are set aside specifically for small businesses. Likewise, the federal government reserves certain jobs for small businesses.

Even if you don’t plan to use small business loans or procure government contracts, understanding where you fit in to the greater business framework is still valuable. It can help you size up against competitors, scale appropriately, and set reasonable goals.

What is a Sole Proprietorship?

Sole proprietorships are easy-to-form, single-owner businesses. Without any state formation paperwork or fees, they’re an extremely common option for small businesses. Sole proprietorships are taxed as pass-though entities, with profits and losses recorded on the owner’s individual tax return. Sole proprietorships do not come with limited liability. If the business owes any debts, the owner’s personal assets can be claimed.

What is a General Partnership?

General partnerships are similar to sole proprietorships, except that they have two or more owners. State formation paperwork is not required, and owners report business profits and losses on their individual tax returns. General partner liability is limitless, so owners are on the hook for business debts and responsibilities.

What is an LLC (Limited Liability Company)?

Limitied liability companies are single- or multi-owner businesses formed with the state. Starting an LLC provides limited liability to members (owners). This means that if the business owes debt or is sued, members’ personal assets will have some protection. LLCs are taxed as pass-through entities by default, with members reporting business profits and losses on their individual tax returns.

LLCs are flexible in terms of their management and structure, making them a fairly common choice for small business owners.

What is a Corporation?

Corporations are entities incorporated with the state. Corporate ownership is divided into shares of stock, and corporations have the option of eventually going public—meaning stock ownership can be made available to the masses.

A corporation is separate from its shareholders (owners), providing them with limited liability. This separation is also relevant in regard to taxes. Corporations are met with a federal corporate tax, and many states have their own corporate taxes as well.

Can I change my entity type?

Yes. You can change your business structure, but how you do so depends on what type of entity you currently have and what you’re changing it to. It is most common to go from being an unincorporated entity to an incorporated one.

For example, to change from operating as a sole proprietor to an LLC, you need to file the required state paperwork, pay fees, and potentially change your business name to include “LLC” (or similar). To go from an LLC to operating as a sole proprietor, you would need to formally dissolve the LLC.

Name Your Business

Before naming your business, check the business naming rules in your state. Certain words may be required or prohibited depending on your business structure. For example, many states require words such as “Corporation,” “Corp,” or “Inc” to be used if your business is incorporated. If your business is not incorporated, the same words are likely prohibited from use.

You may need to register your business name with the state. Check your state’s rules and regulations.

Find Funding

Small business funding often comes straight from the owner(s). Another common option is a small business loan. Many different business loans exist, including loans guaranteed by the SBA and backed by the federal government. These private-lender loans aim to reduce risks for lenders and borrowers. SBA-guaranteed loans are reserved for small, for-profit, U.S. businesses that meet the SBA’s size standards.

If a small business is aiming for rapid startup company growth, venture capital is a potential funding option. Venture capital is a type of equity financing in which ownership percentage is exchanged for funds.

Open a Business Bank Account

Having a business bank account helps separate your personal finances from your business finances. Using a business bank account increases liability protection, as it helps make clear that your business and personal expenses are divided.

Choose an Entity Type

Deciding which entity type is right for your small business can be difficult. While many small business owners begin as sole proprietors, forming an LLC or corporation provides greater liability protection and increases investment, sale, partnership, and expansion opportunities down the line.

Get Business Licenses and Permits

Many businesses need to obtain a license and/or permit prior to beginning operations. Whether this applies to your business depends on your business activity and jurisdiction.

Business licenses can be required at the state, local, and industry level. Business permits are usually issued locally for a certain business activities, such as being a street vendor or operating a business out of your home.