Tips for Deciding What Type of Business Entity to Form
What should you consider when choosing your business entity type for your new business?The various types of business entities each have their aspects that can help you decide which entity type is best for you. Some of the fundamental factors to consider include the following:
1. How complex is it to form the business entity?
2. Do you anticipate any any financing or credit needs that one entity type could more easily handle?
3. Do you want to have flexibility to allocate profits and losses or do you prefer a more rigid structure?
4. Are you trying to limit personal liability?
5. Do you want to make it easy for the company to allow owners to sell (or otherwise transfer) their ownership interests?
6. How do you want profits and losses to be treated from a tax viewpoint?
What types of business entities are available?There are normally four main types of businesses people use.
Each of the most common business entities have their own formation and operation requirements. The basic four types of business entities and their sub-groups are:
1. Sole proprietorship:
a. General partnership
b. Limited partnership
a. Regular corporation (S or C)
b. Statutory close corporation
c. Professional corporations
4. Limited Liability Companies
There are other types of possible business entity types such as the business trust or registered limited liability partnership but such entities are not nearly as frequently used. You could also set up, for example, a limited partnership with a corporation as the general partner.
Corporations and Sole ProprietorshipsThe different types of entities can be differentiated by their management structure, liability limitations, ownership interest transferability, and how and if the business continues after death, retirement, or transfer of ownership interests.
Corporations: Normally corporations have centralized management and are controlled by a small group of top managers who manage on behalf of all the shareholders. The shareholders liability is limited to their investment in the company because they will not be held accountable for the company's debts. A corporation's shares are relatively easy to sell or otherwise transfer and transfers do not cause a corporation to dissolve.
Sole Proprietorship: A sole proprietorship is in some ways like a general partnership except that with a sole proprietorship there is only one single owner.
General Partnership - Partnerships differ from corporations in that they have decentralized management. In a general partnership each of the partners has the right to participate in business management unless the partners agree otherwise. In a partnership, the general partner has unlimited personal liability for the company's debts and other obligations so many times you will see another business entity as the general partner. Also, if a general partner leaves the partnership dissolution may occur which ends the partnership's business.
Limited Partnership - A limited partnership runs like a general partnership except that the limited partners do not have the unlimited liability of a general partner and the limited partners have limited management input along with their liability being limited to their investment in the company.
LLCLimited Liability Company: The LLC has become popular because it allows each of the owners to participate in the management of the business yet avoid the liability of a general partner.