What Type of Business is a Restaurant?

The question “What type of business is a restaurant?” often comes up as entrepreneurs start thinking about how to structure their business in order to improve liability protection and tax compliance. From LLCs to corporations, business owners have many choices in terms of organizational structure for their new establishments, each option having its pros and cons. 

If you’re not sure what type of business entity is best for a restaurant, this guide will provide some clarity by outlining 5 potential legal structures and explaining their differences. By understanding how ownership structures vary, you can better select the one that’s right for your restaurant startup.

Sole Proprietorship

The simplest legal structure is a sole proprietorship, an unincorporated business in which a single person owns and operates the business alone. There’s no distinction between the owner and the business, so profits are “passed through” and taxed as ordinary income. Since the individual and business are considered as one, personal assets are at risk from litigation. Although the owner’s name is the business’s name by default, registering a doing business as (DBA) name allows for more creativity and better branding.

Even if setting up a sole proprietorship and registering a DBA name is fairly straightforward, the lack of liability protection should be a concern for entrepreneurs. Considering that litigation risks for restaurants range from slippery floors to food poisoning, sole proprietorships are likely best for simpler, lower-risk businesses like farmers’ market vendors and food trucks.

Partnership

A partnership is an unincorporated business in which two or more people operate a venture and share its profits. As with sole proprietorships, the “pass-through” profits are taxed as ordinary income and usually there’s no protection for personal assets. However, there are many types of partnerships, each with different levels of personal liability and legal obligations. For instance, a limited liability partnership (LLP) offers more asset protection, and limited partnerships (LP) allow silent investors to fund a business and receive profits without having any liability.

The main advantage of partnerships is that they allow multiple people to start a business together in a simple way. Limited partnerships may be especially helpful if investors want to fund a restaurant and receive profits but don’t want to operate the business. However, due to limited asset protection, partnerships may not be ideal for most foodservice establishments.

Limited Liability Company (LLC)

If you ask “What type of business is a restaurant,” the answer is very likely a limited liability company (LLC). Whether a single or multi-member organization, an LLC is an incorporated business that has the “pass-through” taxation of a sole proprietorship or partnership along with added personal asset protection. Limited liability companies also require more paperwork to form and maintain, such as the LLC annual report that’s submitted to the state government.

In spite of the additional paperwork, LLCs are popular organizational structures in the restaurant industry because the legal separation between the owner(s) and business safeguards personal assets. Moreover, financial institutions such as banks often see incorporated businesses as more serious and professional, so getting funding for a restaurant may be easier with an LLC than with a sole proprietorship or partnership.

C Corporations (C Corp)

Often referred to as simply “corporations,” C Corporations are incorporated entities that offer personal asset protection for their founding shareholders. Although single-member C Corps exist, most have multiple founders and other shareholders who own company stock. However, unlike LLCs, corporations don’t “pass through” profits to owners; instead, they pay taxes on their profits before paying founding shareholders their salaries and/or dividends.

While the organizational structure and legal requirements are stricter, C Corps have advantages over LLCs. First, dividends aren’t subject to payroll taxes, allowing owners to bypass some taxes on a portion of the profits. Second, the biggest benefit of a C Corp is arguably the ability to raise capital by selling shares. Although a new restaurant can be a C Corp, it’s likely best to start as an LLC and then change to a C Corp if you want to raise money to expand the business into a large chain.

S Corporation (S Corp)

Unlike a C Corp, an S Corporation is an incorporated pass-through entity in which profits are taxed as ordinary income for the founding shareholder(s). S corps also give founders the ability to receive both salaries and payroll tax-exempt distributions. Although S Corps can’t raise money by selling shares like C corporations, S corps can give employees stock options as a form of compensation.

The main benefit of S Corps is the reduced tax burden. In addition to being pass-through entities in which profits aren’t “double taxed” as with C Corps, receiving distributions helps entrepreneurs avoid payroll taxes on a portion of their income. However, S Corps can’t have more than 100 shareholders, so they would be best for large restaurants or small chains with just a few locations if the owners are willing to trade a bit more paperwork for lower taxes.