What are the different types of business entities?
Starting a business goes beyond choosing the type of product or service you want to provide. You need to determine the business structure, as this factor will significantly affect how you operate, the tax structure, how you'll raise money from investors, and the risks you'll have to deal with in a legal battle. Different Types of business entities exist, each with its mode of operation. This article will look at the types of business structures to help determine which is best for you.
Limited Liability Company
A Limited Liability Companies (LLCs) is a hybrid entity structure that combines features of sole proprietorships and corporations. An LLC is owned by a single member or multiple members. An LLC is governed by an operating agreement that establishes who the members are, what their membership interests are, and how the company will be ran. LLCs are separate entities from their owners, so LLC members cannot be held liable whenever things go wrong. An LLC also has the freedom to decide the tax structure of the business. However, LLCs typically pay federal taxes like sole proprietors or partnerships: through the members' personal tax returns. LLCs can be complex to establish due to the legal paperwork and fees required, and most LLCs must be maintained by paying an annual fee. The downside to forming an LLC is that it is often challenging for LLCs to attract investment funds from venture capitalists and grant shares in an LLC.
Corporation
A corporation is an entity structure that is independent of their owners. A corporation is owned by its shareholders, and is typically managed by a board of directors and officers. Corporations are managed more strictly than LLCs, and require more formalities to maintain its corporate structure. Corporations are taxed differently than LLCs: a corporation pays taxes for itself, and each shareholder pays taxes for their personal income from the company’s dividends. However, a corporation provides owners with the most liability protection when it is established and maintained properly.
Sole Proprietorship
A sole proprietorship is the easiest type of business to set up. You typically don't register a sole proprietorship with the state, and tax filing is less complex than other business types. However, in a sole proprietorship, you're legally liable for the business's debts and liabilities since there's no separation between you and the company. That means any legal claim brought against your business will be considered a claim against you personally. Raising capital for a sole proprietorship is also more challenging as investors prefer corporations and LLCs.
Partnerships
Partnerships are similar to sole proprietorships, as they're straightforward to establish and don't require registration with the state. However, unlike a sole proprietorship, more than one person is responsible for a partnership. Two types of partnerships typically exist: general partnerships and limited partnerships. In general partnerships, all partners own and manage the company and are legally liable for its debts. However, in limited partnerships, there are two types of partners: general partners and limited partners. General partners actively manage the day-to-day running of the business, and they're also 100% liable for any challenges the company may face. On the other hand, limited partners are more like investors. They do not actively manage the company daily and are only liable for the company's debts relative to their investment percentage.
Conclusion
Starting a business is a huge decision that should be taken seriously. Rather than jumping in head-first, you need to do due diligence, especially on the type of business structure you want to run. Check out our Attorney’s Step-by-Step Guide to Forming Your Small Business to get all the information and resources you need to start your business off on the right foot.