You have a great concept for a business, but before you move on to developing your buy-sell agreement, do you know what the best structure or entity type is for you? The entity type is crucial to the success of a business and can have drastic legal and tax consequences for a company. As a business owner, it is your responsibility to understand the structure of the business you are creating and your personal stake within the company.
Why is choosing a business entity structure important?
A business entity is the legal and organizational structure of a business created by an individual or a group. Entity structures vary based on liability, transferability, cost, taxation, and simplicity. Choosing your entity structure is one of the most important decisions to make when starting your business because it affects business decisions, tax efficiencies, and your ability to scale.
How do I choose the right entity structure for my business?
Choosing an entity is a major decision. To get started, make note of priorities you have within your business. Click here to download a flow chart to give you a better idea of which entity structure might work best for you. Consider how much liability, taxation, investors, and costs you want to be responsible for as a business owner.
As you read the chart and the four most common entity structures below, you’re going to want to be familiar with the following terms:
- Publicly traded: A company whose ownership is traded on a stock exchange or in over-the-counter markets. A benefit of going public is the ability to raise capital quickly, grow your company, and attract quality talent.
- Pass-through taxation: A company with pass-through taxation means that the business itself does not pay taxes. Instead the owner pays the taxes on their personal tax return. This can be advantageous for an owner because it avoids double taxation on the business earnings.
- This only applies to LLCs, sole proprietorships, partnerships, and S-Corporations.
- Unlimited personal liability for business debts: A company owner is liable for any lawsuits or debt obligations against the business. This means personal assets and property of the business owners or members are at risk.
- The two business entities subject to unlimited personal liability are sole proprietorships and general partnerships.
- Managerial rights: The right to run your business in any manner you see fit, within the scope of state and federal laws. This includes being involved in day-to-day operations, access to business information, and having a say in any aspect of the business.
- Most owners of an entity have managerial rights with the exception of a limited partner. In this case, the partner can still vote on certain topics within the business.
- Social mission: A cause that benefits society, the economy, or the environment in a positive manner. A company with a social mission focuses on making a profit while fulfilling their mission statement and doing good in the world. They are responsible for meeting higher standards of transparency, accountability, and performance.
What are the most common business entities?
There are four common business entity structures: Corporations, Partnerships, Limited Liability Companies, and Sole Proprietorships.
A corporation is a legal entity that is separate from its owners. It can make a profit, be taxed, and be held legally liable. Common types of corporations are C-corporations, S-corporations, and B-corporations.
- Offers the strongest protection against personal liability for its owners
- Easily transferrable
- Can raise funds through the sale of stock
- Higher cost to form than other structures
- Extensive record-keeping, operational processes, and reporting
- Pay income tax on their profits – meaning they are taxed twice – once on profits and again on personal tax returns of shareholders receiving dividends
Partnerships area simple business structure between two or more people. It is legally and financially inseparable from its owners. There are two common types of partnerships: a general partnership and a limited partnership. There are other types of partnerships, but some are not authorized in all states or only apply to certain professions and situations.
In a general partnership, each partner has total liability and all partners are equal, unless specified in a partnership agreement.
A limited partnership is authorized by the state and consists of one general partner who is fully liable and one or more limited partners who solely provide money. Limited partners are only liable for their investment within the business which keeps their personal assets safe.
- Easier and less costly to set up than a corporation
- Pass-through taxation means fewer taxes
- Simple entity structure to test a business idea before forming more formally
- Legal and financial liability shared equally between general partners
- Partners are liable for each other’s decisions
- General partners risk their personal assets
- Entity can dissolve with the death or bankruptcy of a partner
- Limited ability to raise capital
Limited Liability Company
A limited liability company (LLC) is a business entity that combines the aspects of a partnership and a corporation. It allows members to take advantage of pass-through taxation and protects them from individual legal liability.
- Protection against personal liability
- Pass-through taxation means avoiding double taxation
- Simple legal requirements
- Harder to raise capital with no stock options
- Different regulations depending on the state
- Company would dissolve with the death of a member
- Transfer of ownership can be difficult
A sole proprietorship gives you complete control of your business, but does not produce a separate business entity. This is the most common business entity structure.
- Easy to form
- Owner has full control of their business
- Good for testing a business before incorporating
- Personal liability
- Hard to raise capital
- Banks are hesitant to give those to these businesses
Corrigan Krause Can Help
The Corrigan Krause team is here to help. Our team of experts has extensive experience working with businesses at all stages. Feel free to reach out to your Corrigan Krause team members or email email@example.com.