Whether you are an existing business owner, a new entrepreneur, or an investor, forming a business entity is an intelligent step. This article will explain the different types of business forms you can choose from.
There are many reasons to start a business and no matter what industry you are in there are some important things to know before moving forward and filing documentation with your state. There are a few different business forms to choose from: Sole Proprietorship, Partnership, Corporation, and Limited Liability Company (LLC).
Depending on the type of business form you choose, you may be forming a new "entity", which by definition is something that has a distinct and separate existence from yourself. In essence, by setting up certain business entities (aka legal business structures), you are creating an "umbrella of protection" between your business and your personal assets (your home, automobiles, bank accounts, etc.).
Sole Proprietorship
A Sole Proprietorship is not a business entity. It is owned and run by one individual person and there is no legal distinction between the owner and the business. A Sole Proprietor usually operates under a "fictitious name" (ex: Bob's Flower Shop), but this is just a "nickname" for the real person behind the business.
A Sole Proprietor has unlimited liability for all debts of the business. Many who elect to be a Sole Proprietor are often unaware of the types of business entities that exist or they think that it is too expensive to form one, and therefore are exposing themselves to unnecessary risk. As an example, if a flower shop owner (operating as a Sole Proprietorship) is sued by a customer because of an accident that occurred at the shop, the business owner's personal assets (home, automobiles, saving accounts, retirement funds, etc) are all exposed and could be seized in court.
There are no legal formalities or paperwork required to start a business as a Sole Proprietor. You simply just start operating the business. A plus to this type of business is that the income or loss from the business will be reported on the individual's income tax return.
Again, an individual acting as a Sole Proprietor is often unaware of the other business entities and does not know that what is called "pass through taxation" also occurs in a Partnership and in an LLC.
General Partnerships
General Partnerships consist of two or more people coming together for the purpose of operating a business and sharing in the profits of such endeavor. There is no official paperwork that needs to be filed with the state to create a Partnership; the partners just simply start working together.
It is advisable to draft and sign a Partnership Agreement, however it is not a state requirement. As in a Sole Proprietorship, the partners essentially are the business and they have unlimited liability. In the event of a lawsuit, the partners would be completely liable and their personal assets would be at risk of being seized.
The income and expenses of Partnerships are reported on a separate return for tax purposes, but each partner then reports his or her pro-rata share of the profits or losses from the business on their personal tax return.
There are no real advantages of a General Partnership, as all partners would be held personally responsible for all debts and liabilities if the company is sued or enters into bankruptcy. General Partnerships are quite old and new business entities have since been created (Corporations, Limited Partnerships, and LLCs) which are more advantageous to business owners.
Corporations
A Corporation is owned by shareholders. Shareholders have limited liability and invest money for a certain amount of ownership (issued in shares) in the business. They then elect a board of directors, who in turn, elect the corporate officers. The board of directors make the business decisions and oversee policies and the corporate officers carry out those decisions.
The main disadvantage of a Corporation is what is known as "double taxation". Corporations are taxed on their earnings at a corporate level and then the shareholders are taxed again on any distributed dividends.
Corporations are not usually the best choice for small business owners and entrepreneurs, as they are more complicated and expensive to maintain. Corporations are required to hold annual shareholders' and directors' meetings to elect (or re-elect) the board of directors and officers. During all meetings, Corporations are also required to draft corporate minutes (legal, written records that document actions taken and approve business decisions).
However, if you plan on raising substantial outside capital (angel investors, venture capital, etc), or going public (via an IPO, or initial public offering), a Corporation may be the better choice for you.
Limited Liability Company (LLC)
An LLC is a Limited Liability Company. It is often referred to as a "hybrid" as it combines the liability protection of a Corporation with the "pass through taxation" benefits of a Partnership.
An LLC is a business structure that allows the owners, called "members", to be taxed individually instead of the business paying taxes at the corporate level (therefore avoiding double taxation). If an LLC member is also a W2 employee, certain business write-offs can offset their income, therefore reducing their personal income taxes.
An LLC is not required to hold annual meetings and its filing paperwork is much easier than a Corporation.
An LLC also protects the members' personal assets. In the event of business bad debts or a lawsuit against the company, the members' personal assets (such as personal savings, primary residence, automobiles, etc) are not at risk. This is an advantage only stockholders of a Corporation usually enjoyed, however an LLC also has the exact same level of protection.
An LLC can have a single member or multiple members. There is no limit to the number of members an LLC can have. A single-member LLC can also add additional members (business partners) in the future.
A Limited Liability Company is a statutory creation, meaning that it is created under state law. It is considered a separate entity from the owners. An LLC is formed by filing the proper LLC formation documents with the state.
LLCs are the most common and the most popular form of legal business structure because of the asset protection it creates for its members. Other advantages of an LLC include the lack of requirements to hold annual meetings, the ease of pass through taxation, and the flexibility to set members' own rules for operating procedures and profit distribution.
There are many reasons to start a business and no matter what industry you are in there are some important things to know before moving forward and filing documentation with your state. There are a few different business forms to choose from: Sole Proprietorship, Partnership, Corporation, and Limited Liability Company (LLC).
Depending on the type of business form you choose, you may be forming a new "entity", which by definition is something that has a distinct and separate existence from yourself. In essence, by setting up certain business entities (aka legal business structures), you are creating an "umbrella of protection" between your business and your personal assets (your home, automobiles, bank accounts, etc.).
Sole Proprietorship
A Sole Proprietorship is not a business entity. It is owned and run by one individual person and there is no legal distinction between the owner and the business. A Sole Proprietor usually operates under a "fictitious name" (ex: Bob's Flower Shop), but this is just a "nickname" for the real person behind the business.
A Sole Proprietor has unlimited liability for all debts of the business. Many who elect to be a Sole Proprietor are often unaware of the types of business entities that exist or they think that it is too expensive to form one, and therefore are exposing themselves to unnecessary risk. As an example, if a flower shop owner (operating as a Sole Proprietorship) is sued by a customer because of an accident that occurred at the shop, the business owner's personal assets (home, automobiles, saving accounts, retirement funds, etc) are all exposed and could be seized in court.
There are no legal formalities or paperwork required to start a business as a Sole Proprietor. You simply just start operating the business. A plus to this type of business is that the income or loss from the business will be reported on the individual's income tax return.
Again, an individual acting as a Sole Proprietor is often unaware of the other business entities and does not know that what is called "pass through taxation" also occurs in a Partnership and in an LLC.
General Partnerships
General Partnerships consist of two or more people coming together for the purpose of operating a business and sharing in the profits of such endeavor. There is no official paperwork that needs to be filed with the state to create a Partnership; the partners just simply start working together.
It is advisable to draft and sign a Partnership Agreement, however it is not a state requirement. As in a Sole Proprietorship, the partners essentially are the business and they have unlimited liability. In the event of a lawsuit, the partners would be completely liable and their personal assets would be at risk of being seized.
The income and expenses of Partnerships are reported on a separate return for tax purposes, but each partner then reports his or her pro-rata share of the profits or losses from the business on their personal tax return.
There are no real advantages of a General Partnership, as all partners would be held personally responsible for all debts and liabilities if the company is sued or enters into bankruptcy. General Partnerships are quite old and new business entities have since been created (Corporations, Limited Partnerships, and LLCs) which are more advantageous to business owners.
Corporations
A Corporation is owned by shareholders. Shareholders have limited liability and invest money for a certain amount of ownership (issued in shares) in the business. They then elect a board of directors, who in turn, elect the corporate officers. The board of directors make the business decisions and oversee policies and the corporate officers carry out those decisions.
The main disadvantage of a Corporation is what is known as "double taxation". Corporations are taxed on their earnings at a corporate level and then the shareholders are taxed again on any distributed dividends.
Corporations are not usually the best choice for small business owners and entrepreneurs, as they are more complicated and expensive to maintain. Corporations are required to hold annual shareholders' and directors' meetings to elect (or re-elect) the board of directors and officers. During all meetings, Corporations are also required to draft corporate minutes (legal, written records that document actions taken and approve business decisions).
However, if you plan on raising substantial outside capital (angel investors, venture capital, etc), or going public (via an IPO, or initial public offering), a Corporation may be the better choice for you.
Limited Liability Company (LLC)
An LLC is a Limited Liability Company. It is often referred to as a "hybrid" as it combines the liability protection of a Corporation with the "pass through taxation" benefits of a Partnership.
An LLC is a business structure that allows the owners, called "members", to be taxed individually instead of the business paying taxes at the corporate level (therefore avoiding double taxation). If an LLC member is also a W2 employee, certain business write-offs can offset their income, therefore reducing their personal income taxes.
An LLC is not required to hold annual meetings and its filing paperwork is much easier than a Corporation.
An LLC also protects the members' personal assets. In the event of business bad debts or a lawsuit against the company, the members' personal assets (such as personal savings, primary residence, automobiles, etc) are not at risk. This is an advantage only stockholders of a Corporation usually enjoyed, however an LLC also has the exact same level of protection.
An LLC can have a single member or multiple members. There is no limit to the number of members an LLC can have. A single-member LLC can also add additional members (business partners) in the future.
A Limited Liability Company is a statutory creation, meaning that it is created under state law. It is considered a separate entity from the owners. An LLC is formed by filing the proper LLC formation documents with the state.
LLCs are the most common and the most popular form of legal business structure because of the asset protection it creates for its members. Other advantages of an LLC include the lack of requirements to hold annual meetings, the ease of pass through taxation, and the flexibility to set members' own rules for operating procedures and profit distribution.
