When starting any business, one of the first decisions you must make is what kind of legal structure it will have. This decision is more important and more complicated than you might think, as your business’s legal structure will ultimately determine how you can raise money for your business, what paperwork your business is required to do, how much you pay in taxes, and how much personal liability you face. The decision becomes all the more complicated when you consider the fact that business incorporation happens at the state level, and therefore your business entity will not be treated the same in every state. Moreover, you may choose to incorporate as one type of entity but be taxed as another (corporate entity versus tax entity).
Choosing the right small business entity is complicated, to be sure, and therefore it’s important to consult a small business professional as you are creating your business plan. As a primer to small business entities, here is a brief look at different legal entities and what the unique advantages are of each for a small business.
This is the simplest and most common type of small business entity. Under a sole proprietorship, the business owner has complete managerial control and holds complete responsibility for the business’s assets and liability. The upside to this type of business is that it is very simple to form; there are no forms to fill out and no documents to file with the state. One drawback to consider, however, is that personal and business assets are transferrable. This can make managing your business simpler, but it also means that your personal assets can be treated as business assets for liability purposes. In other words, you become personally liable for any debts and obligations of the business.
Like sole proprietorships, partnerships are very easy to form. The key difference between a sole proprietorship and a partnership is that a partnership is an association of two or more persons. There are several types of partnerships to be aware of, including general, limited, and limited liability partnerships. Under a general partnership, partners share responsibility over the financial obligations of the business. Under a limited partnership, on the other hand, one or more partners involved has limited liability. Under a limited liability partnership (LLP), the business takes on a form of limited liability similar to that of a corporation. While general and limited partnerships can exist on a relatively informal basis, LLPs must register with the state.
Limited liability company (LLC)
The limited liability company (LLC) seems to be rising in popularity today. An LLC is a hybrid type of partnership where owners are protected from personal liability for financial obligations of the businesses. The business may be taxed as a partnership, where profits and losses are passed through the individual owners, or it may be taxed as a corporation.
A corporation is a more complex type of business entity, and therefore it is generally best for larger companies. There are several types of corporations, but in general, a corporation becomes a separate entity from those who founded it. Therefore, the corporation—and not the owners—is taxed and held legally liable. The major benefit to forming a corporation is that it eliminates personal liability. The downside, however, is that corporations are more expensive to form and involve a great deal more record keeping.