Starting your own business can be an exciting and daunting time. It's a time to make important decisions that can have a lasting impact on the success of your organization and even on the course of your life. Having the right information will help you make the right decisions to set your business up for success. You may be wondering what a type of entity is, or at least you want to get a little more information than you already have.
Business entities are organizations created to conduct business or participate in commerce. An entity type is simply the legal structure of your organization. Your type of entity matters because of its potential legal and financial implications. The type of entity determines how much you pay in taxes for the organization and your legal liability if your company is criticized for litigation.
Your company's type of entity also influences your profit share and the organization's growth potential, such as how easy it is to obtain a small business loan or to get investors. Choosing the right type of entity for your company will set you up for success while minimizing potential risk for you and other executives. The most common forms of business are the sole proprietorship, the joint stock company and the S corporation. A limited liability company (LLC) is a business structure allowed by state law. The most common types of business entities are sole proprietorships, partnerships, limited liability companies, corporations and cooperatives.
Sole ProprietorshipA sole proprietorship is the simplest form of business structure.
It's easy to set up and requires minimal paperwork. The bright side is that you don't have to file a wide variety of reports with the government and you make all the decisions, from keeping all the profits to closing the business, at your discretion. But it's also harder to raise capital, and you assume 100 percent responsibility.
PartnershipPartnerships are similar to businesses in that they start automatically alongside business operations and generally don't require formal registration with the state government. With a partnership, all of the founders are personally responsible for taking legal action against the company, and you declare profits on personal tax forms.
The appeal of partnerships is that you get creative and decision-making support and more capital. But it's also a challenge because of the burden of responsibility and because you share authority with someone and don't always agree.
CorporationThe positive side of operating as a C corporation is that the business is perpetual and can be passed on to heirs, not to mention that individual liability is limited to the amount each person has invested. However, you face double taxation and must obtain a corporate charter from your state.
S CorporationS corporations take advantage of the reduction in personal liability offered to owners of C corporations minus double taxation. S corporations can only have 100 shareholders, which reduces their capacity for growth compared to C corporations.
The good thing about operating like an S corporation is that it's simple for shareholders to sell their shares in the company or even do everything possible and raise capital to expand the company. They are only legally authorized to operate in the state specified in the corporate statutes, unless you obtain another permit.
Limited Liability Company (LLC)Limited Liability Companies (LLCs) give owners the flexibility to choose how their businesses will be taxed. LLCs are legal entities independent of the owner, and the profits go to the owners, who recognize that income on their personal tax returns. The regulations on statutes and board meetings do not apply to LLCs, making LLCs attractive to most small business owners.
LLCs are among the most attractive types of entities because they provide freedom and flexibility. On one hand, there are no limits when it comes to customizing the structure of your business, and you can't be considered fully responsible if things go wrong in any way. However, LLCs are also strict and need 360-degree operating agreements because of their flexibility in other aspects of their business.
GP? LIP? LLC?What does this type of entity mean for your company's future? Choosing the right option sets you up for success as it gives you space to grow while mitigating personal risk. When starting a new business venture, it's important to understand all available options when it comes to legal entities.
Each type has its own advantages and disadvantages that should be taken into consideration before making a decision. Sole proprietorships offer simplicity but lack capital raising potential; partnerships provide creative support but require shared responsibility; corporations offer perpetual life but face double taxation; S corporations provide limited liability but have limited growth potential; and LLCs offer flexibility but require 360-degree operating agreements. No matter which type of entity you choose for your business venture, it's important that you understand all aspects before making a decision so that you can set yourself up for success while minimizing potential risk for yourself and other executives.