Selecting the right business entity is an important decision that could spell the difference between success, failure, personal asset protection and tax obligations. There isn’t one business entity that is ideal for every single business. Your ideal entity depends on several factors, including your industry, location, number of owners and exit strategy.
As a business owner, you should conduct due diligence by impartially considering the benefits and disadvantages of each business entity. Did you know that some entities put your personal bank accounts at risk? Did you know some entities must pay significantly more taxes than others?
Read our summaries and watch the videos below for an overview of each business entity, including their benefits and disadvantages.
Starting With the Basics: Sole Proprietorship
Sole proprietorships are the most common and easiest business structure to form. Sole proprietorships are only allowed for businesses with one owner, and there is no legal distinction between an owner and the business in a sole proprietorship.
Its main benefits include preferable taxation treatment and ease to set up. However, an owner’s personal assets are at risk and can be used to pay the business’ debts or obligations, such as lawsuits.
Two or More Persons: Partnerships
A partnership is owned by two or more persons and is run for a profit. Similar to a sole proprietorship, a partnership is easy to form with minimal upfront costs. Each partner can contribute money, labor or skills in return for an ownership stake in the business.
Its main advantages include taxation benefits and ease to set up. However, personal liability for business obligations is a significant drawback. In addition, partners can disagree on material issues, which can lead to tedious legal battles. Consider implementing a partnership agreement to minimize such risks.
The New Kid: Limited Liability Companies
A relatively recent incarnation, LLCs started sprouting up a few decades ago. Created and governed entirely under state law, LLC owners must elect how they want to be taxed by the IRS (e.g. as a sole proprietorship, partnership or corporation).
LLCs offer practicality and flexibility. They combine the limited liability of corporations with the taxation benefits of partnerships. However, depending on state law, they can cease to exist if an owner departs or dies.
The Big Business Entity: C Corporations
If you have aspirations of going public on a stock exchange, a C corporation is your ideal route. Considered a distinct legal entity from its owners (called “shareholders”), C corporations provide limited liability protection to shareholders, insulating personal assets from business debts.
However, C corporations are subject to “double taxation” and don’t receive preferential tax treatment. The C corporation’s profits are taxed once at the corporate level, and shareholders are taxed again at the individual level. In addition, if complex formalities aren’t followed, shareholders can forfeit their limited liability status and be held personally liable for the C corporation’s debts and obligations.
The Small Business Alternative: S Corporations
Another recent incarnation, S corporations offer small businesses taxation relief. Considered the little sister of C corporations, S corporations combine the limited liability protection of C corporations with the taxation benefits of sole proprietorships and partnerships.
On the other hand, not all businesses will be eligible for S corporation election. If you have more than 100 shareholders or have shareholders that are not natural individuals, you will not be eligible for S corporation election. Additionally, shareholders can lose their limited liability protection if corporate formalities aren’t followed.
Take Your Time and Consider Your Options
As you can see, selecting a business entity is not as easy as it seems. It’s imperative that you take your time and do research before selecting a business entity that’s right for you.