Choosing a Business Entity
Choosing the business entity type is one of the most important considerations when starting a business. Business owners must consider the amount of liability they want to assume, tax implications for the business, how the business will be financed, control of the business, how long the business will exist and how business interests can be transferred.
A sole proprietorship is run by an individual owner, whose activities are basically inseparable from the activities of the sole proprietorship. The owner of a sole proprietorship faces unlimited personal liability for business losses. Income from the business is generally taxed as personal income to the owner. Setting up a sole proprietorship is fairly easy due to the relative simplicity in structure, formation and management. A sole proprietorship is funded through the personal assets of the owner and it can continue to exist during the owner’s lifetime.
A corporation provides limited liability to its members, so that they will generally not be personally liable for any of the corporation’s debts. A board of directors runs a corporation, although some corporations may be directly controlled by the shareholders. S-corporations and C-corporations are distinguished by their tax treatment. Non-profit organizations can also incorporate to protect management from liability.
Unlike a sole proprietorship which can only exist during the owner’s lifetime, a corporation can exist in perpetuity. Another advantage of a corporation is the ease in which it may transfer assets. A few disadvantages of corporations includes double taxation via corporate tax on the corporation’s earnings and an individual tax on shareholders’ earnings, as well as the cost and expenses of setting up and maintaining a formal corporate structure.
Partnerships can be either general partnerships or limited partnerships. General partners are jointly and severally liable for the debts of the partnership, while limited partners are liable only up to the amount of their capital contribution. Partners can dictate the terms of the partnership in a partnership agreement. General partners control the partnership; limited partners must not exercise control if they want to maintain limited liability status. Financing for the partnership can come from contributions of the partners or third parties.
Advantages of a partnership include limited formalities and the ability to dictate terms of the partnership. A disadvantage of a partnership is that it ends when the partners go their separate ways, and this can be at an inopportune time for the business.
Limited Liability Company (LLC)
A limited liability company’s primary advantage is conveyed in its name: limited personal liability for the company’s obligations. Either a member or a third party will manage the LLC under the terms of an operating agreement. Members contribute to the financing of the LLC and may have security interests that are subject to state and federal laws. LLCs may choose to be taxed as a partnership or corporation, depending on the particular need of that LLC. LLCs also have other tax advantages for members.
Franchises and distributorships are another type of business ownership that entrepreneurs frequently pursue. Basically, a franchise is an agreement between a franchisor and an entrepreneur to license a trade name or trademark so that the entrepreneur can sell products (sometimes referred to as a distributorship) or services bearing the name or mark.
Business owners may also consider other entities such as cooperatives and associations, depending on the goals of the business. For more information or help choosing your structure and setting up your business, feel free to contact me.