We have a directory that we're building and we're not sure if we should try to make each page an extension of the root domain or utilize sub-directories as users narrow down their selection. What is the best practice here for maximizing your SERP authority?

Choice #1 - Hyphenated Architecture (no sub-folders):

1. State Page /state/
2. City Page /city-state/
3. Business Page /business-city-state/
   4) Location Page  /locationname-city-state/

or....

Choice #2 - Using sub-folders on drill down:

1. State Page /state/
2. City Page /state/city
3. Business Page /state/city/business/
   4) Location Page  /locationname-city-state/

Again, just to clarify, I need help in determining what the best methodology is for achieving the greatest SEO benefits. Just by looking it would seem that choice #1 would work better because the URL's are very clear and SEF. But, at the same time it may be less intuitive for search. I'm not sure.

What do you think?