Choosing a Business Entity When Forming Your Company
Choosing a Business Entity When Forming Your Company
Updated: Jan 14
Starting a business is not easy. Entrepreneurs spend a lot of time thinking of the appropriate approach, sector, and goals in order to establish a successful business. Building a business from scratch also demands a lot of time, effort, and entrepreneurial expertise. Not only do business owners have to generate capital but they must recruit an efficient staff, develop and implement creative marketing strategies, grow a strong brand awareness, and meet the needs of their clients or customers.
However, the most vital step in establishing a successful business is choosing the most suitable corporate entity for your specific venture. This is especially important if you intend to avoid financial, legal, and tax issues.
In this article, we’ll discuss the various corporate entity structures that you might choose for your fledgling business.
Corporate entity structures enable business owners to regulate the amount of taxes they pay and to help them determine overall risk exposure. The type of structure one chooses is directly proportional to how easily the business can obtain loans or raise funds from prospective investors. About fifteen corporate entity formations exist, such as:
Limited Liability Company
Limited Liability Limited Partnership
Limited Liability Partnership
Professional Limited Liability Company
Nevertheless, here are some of the most common corporate entities that entrepreneurs can choose from, based on the goals of a business:
This is the simplest business formation that exists and is not necessarily a corporate formation. Instead, this formation refers to the one individual who owns the business. In essence, it enables a one-person owner to assume the risk of running the business and to use his or her own name without being accountable to anyone else. For instance, let’s say that Mary Jamie wants to own a pet salon. Well, she can name the business Mary Jamie Pet Salon. If she chooses to use her name, no legal entity for her business is created separate from her, as the owner.
Additionally a sole proprietorship does not require the owner to register their business in the state where they’re operating the business. They can simply start operating. But, depending upon the industry, the owner may be required to obtain local permits or licenses. If they plan on using a name different than their own, they may also be required to file an assumed business name certificate or a fictitious name certificate. This certificate enables them to “do business as” another entity without having to create a brand-new business entity.
Some advantages of a sole proprietorship are:
It doesn’t cost a lot of up-front money.
It’s easier to file taxes than compared to other formations which require corporate tax filings.
No annual reports must be filed.
Some disadvantages of a sole proprietorship are:
You, as the sole owner, have the full financial burden, as you must cover all costs.
You, the owner, may have a harder time raising money.
Establishing business credit may be more difficult too.
You have unlimited personal liability for the business’s debts.
This business formation is quite similar to the sole proprietorship, but the main difference is that typically two or more people are its owners. The ownership is commonly split between all partners who share profits, assets, and legal liabilities. However, the owners are subject to unlimited personal liability for the business’s debts.
Some advantages of a general partnership are:
You have less financial burden and can share the running of the business with your partners.
You have no corporate tax forms to fill out.
This business formation enables the profits and losses to be equally shared among the partners.
Some disadvantages of a general partnership are:
Each owner is equally responsible for the debts and liabilities of the business.
Each owner/partner is an agent of the other and thus responsible for the corporate actions of teach partner.
Disputes between partners can have devastating effects on the business.
Partners can’t make decisions without the approval of the other partner(s).
Partners have to split profits with all partners.
If one partner decides to leave the partnership, valuation of the general partnership’s assets may be difficult to compute. Plus it may be costly to dissolve the partnership, whether divvying up assets or incurring legal fees or both.
LIMITED PARTNERSHIP (LP)
This is another type of business formation. With a limited partnership you have a general partner, who is like a manager or a representative of the firm. That person is responsible for managing the business’s operations and is liable for the business or has unlimited personal responsibility for the business debts. In contrast, the limited partner is more like an investor, who (unlike the general managing partner) doesn’t manage the day-to-day business operations and who has a limited liability owed to the business.
Some advantages of a limited partnership are:
Lower start-up costs and the ability to work with a partner.
A limited partnership is typically easier to raise funds for.
If you’re a limited partner, your liability for the business debts is limited. That is, you’re only liable or personally responsible for the part of funds that you invested into the partnership.
Some disadvantages of a limited partnership are:
The general partner is responsible for the company’s debts, and the general partner’s personal assets may be at risk. For those who wish to avoid such personal responsibility, they can set up an LLC.
The general partner must oversee day-to-day operations.
LIMITED LIABILITY COMPANY (LLC)
This is a culmination of all the positive features of other corporate entities. It is an organization consisting of numerous owners, often called members, and none of them are personally liable for the company’s liabilities or debts
Some advantages of an LLC are:
Allows for a flexible management styles to handle business operations.
Allows the business to choose how the IRS will levy taxation on the business. Also, profits are disbursed to members based on their personal tax levels.
Requires less documentation and is similar to a sole proprietorship.
Some disadvantages of an LLC are:
An LLC can be a bit more expensive to operate than a sole proprietorship.
A corporate bank account is required.
An LLC may have to pay unemployment compensation.
It is very important that members keep solid and clear records of business dealings.
In conclusion, starting a business is not easy but can be extremely rewarding. Entrepreneurs who have a solid understanding of how each business entity works can choose the best formation for their needs—or should consult their attorney or accountant for recommendations. Either way, when choosing the optimal business structure between an LLC, a sole proprietorship, a general partnership, and a limited partnership, one must consider many essential factors, like tax ramifications, legal protection, and documentation required.
This article is made available by Carpenter Wellington (www.carpenterwellington.com) to provide a general understanding of the topic set forth therein. In no way should this article be construed as specific legal advice, nor does the receipt of this article create no attorney client relationship in on itself, between you (the reader) and Carpenter Wellington. This article, in whole or in part, should not be used as a substitute for competent legal advice from a licensed professional attorney in your jurisdiction.