A business entity formed for the purposes of housing a business, property, or even intellectual property. Business entities, like an LLC, are created or formed at a state level, often the applicable Secretary of State. They vary depending on your business structure, so it is important to know where your business fits. Generally speaking, there are four types of entities to choose from:
A Limited Liability Company, aka LLC, is a business entity recognized in all U.S. states. An LLC has some of the benefits of both a sole proprietorship and a corporation – from both a taxation as well as legal standpoint. It allows the owner to file a simpler tax return, and also limits the owner’s liability like a corporation.
When most people think about setting up a formal business entity, they almost always first think of an LLC, because of an LLC’s reputation of being “easier” overall to run. But, always consult your accountant or CPA before selecting this entity, as it may not give you the tax benefits you were hoping for. From a legal standpoint, an LLC does get you the limited liability most people want in a formal entity.
Conversely, sole proprietorships are subject to unlimited liability. This means that in the event your business ever ends up in hot water from a legal perspective, all your assets – including the owner’s personal assets – are on the hook. On the other hand, most formal business entities carry the added benefit of “limited liability,” meaning that the owners of the company won’t be personally liable for any legal missteps the company makes.
Sometimes LLCs are mistakenly referred to as “Limited Liability Corporations.” But don’t be confused, an LLC is not a corporation. They have completely different structures, ownership, and rules governing them.
An LLC is easier to form over a corporation because no by-laws or corporate charter is required. Also, LLCs are creatures of contract, meaning however the members -or owners- of an LLC agree to run the LLC will govern. Typically, this is handled by way of an operating agreement, effectively the governing document of the LLC.
Operating agreements are considered more flexible than corporate bylaws, which is why some prefer LLCs to corporations. Additionally, there are no meeting requirements imposed by statute like there are with corporations. Nevertheless, An LLC is still watched closely by state and federal agencies to make sure it is being operated separately from the owners’ personal financial and tax lives.
There are two types of LLCs: domestic and foreign. If you form an LLC in the state which you plan to conduct business, you are forming a domestic LLC. If your LLC does business in another state, but is registered in your home state, you may wish to register your LLC as a foreign LLC in the states in which you are transacting business aside from the home state.
Corporations are businesses that are separate and distinct from their owners. Corporations are comprised of shareholders, and typically a board of directors, but it’s the shareholders who own the corporation. Shares can be held by a few individuals, or they might be offered for sale to the public, making them “publicly held”. Corporations are either non-profit or a for-profit business. They can also be formed for a specific short-term purpose.
There are two basic types of corporations; those with stock and those without no stock. Corporations can also be C-corporations and S-corporations. Most people worry about setting up a corporation because of the dreaded “double-taxation.” However, S-Corporations (referring to Subchapter S of the tax code) are not subject to double taxation. If a corporation issues no stock, most likely it will be a non-profit corporation. Corporations are considered older, more traditional business structures.
They’re less likely to be audited by the IRS, and are often the preferred structure for investors. There are annual meeting requirements imposed by statute, but these are relatively straightforward and painless, depending on the number of shareholders.
A sole proprietorship is an unincorporated business owned by one individual. It is the simplest form of business to start and operate. It is also the most popular form of ownership, with over 20 million sole proprietorships operating in the U.S. and Canada.
Unlike an incorporated business or a partnership there is no legal separation between the business and the owner for a sole proprietorship – the business is an extension of the owner and so the owner is personally responsible for any debts or liabilities the business creates.
If you operate your business under your own name, with no additions, you don’t even need to register your business name to begin operating. This is an ideal choice for business startups, self-employed contractors, part-time and home-based businesses. You own 100% of the business and get to make all the decisions. You’re also not required to hold shareholders’ meetings or take votes on management issues. Basically, you get full control!
Unfortunately, some businesses, government agencies, and consulting groups will not work with unincorporated businesses suggesting their legitimacy or professionalism fall at a lower level. You can also run into difficulties raising capital or selling your business. As with anything in business, there are pros and cons.
There are various types of partnerships: general partnerships, limited partnerships, limited liability partnerships and limited liability limited partnerships. In general, partnerships in business is similar to a personal partnership. Business and personal partnerships involve: pooling funds, sharing skills and resources and sharing in the rise and fall of business.
A business partnership is a specific kind of legal relationship formed between two or more individuals to operate a business as co-owners. Each partner is an owner of the business who have invested their time and/or capital in some way. Some partners work in the business, while other partners have limited participation, and even limited liability for the debts or lawsuits.
Generally speaking, a partnership is not a separate entity from the individual owners. The income tax is paid by the partnership, but the profits and losses are divided and paid by partners based on their initial agreement. They are referred to as a pass-through business, meaning the profits and losses of the business pass through to the owners.
However, some types of partnerships need to be registered with the applicable secretary of state. Partnerships almost always use an agreement to clarify the relationship between the partners, the roles, responsibilities, and their respective shares in the profits or losses of the partnership. This is known as a “partnership agreement.”
Before you start a partnership, you will need to decide what type of partnership you want, and this can be tricky as the different types of partnerships impute different liability/participation to the partners.
How do you know which one is right for you?
Whatever business entity you ultimately choose will shape your journey as a business, and choosing the best structure for your company requires time and consideration. Each business entity comes with its own pros and cons. The key is to figure out which structure gives your business the proper advantages to help you achieve your personal and financial goals.
A formal setup and proper partnership/corporate documents are vital to the structure and function of your business. Without knowing your options you could miss out on an opportunity to establish yourself best as possible, contributing to a long-lasting and successful business from the very beginning.