Choosing the Legal Entity for Your Business

If you are thinking about starting your own business, you will want to take the time to understand the business entity options available to you. Choosing the appropriate business entity is important because your entity choice will impact your exposure to liabilities, taxes, and your ability to finance and conduct your business.

Here is a rundown of the most widely used business entities, along with the respective advantages and disadvantages:

• Sole proprietorship
  • Advantages
    • Ease of setup (need only licensing/permits and fictitious business name filing)
    • Pass through entity (profits/losses not taxed at the business level)
  • Disadvantages
    • Owner personally liable for business debts
• Partnership
  • General Partnership
    • Advantages
      • Ease of setup (only requires an intent to form a business relationship between two people)
      • Pass through entity (profits/losses not taxed at the business level)
    • Disadvantages
      • Each partner personally liable for partnership debts
      • Written partnership agreement required to override unfavorable state default provisions
  • Limited Partnership
    • Advantages
      • Limited partners liable only to the extent of their capital contribution
      • Pass through entity (profits/losses not taxed at the business level)
    • Disadvantages
      • Still requires a general partner who is personally responsible for partnership’s debts
      • Limited partners cannot actively manage the partnership
      • Written partnership agreement required to override unfavorable state default provisions
  • Limited Liability Partnership
    • Advantages
      • Limited partners’ liable only to extent of his/her capital investment
      • Pass through entity (profits/losses not taxed at the business level)
    • Disadvantages
      • Can only be used by certain professional partnerships (i.e., law and accounting firms)
      • Written partnership agreement required to override unfavorable state default provisions
• Limited Liability Company
  • Advantages
    • Pass through entity (profits/losses not taxed at the business level)
    • Members liable only to the extent of their capital contribution
  • Disadvantages
    • Must file a certificate of formation or articles of organization
    • Must create an operating agreement (similar to a partnership agreement)
    • Not attractive to venture capital
• Corporation
  • Advantages
    • Shareholders liable only to the extent of their capital contribution
    • Ownership changes are less complicated
  • Disadvantages
    • Double taxation: profits are taxed at both the business level and the personal level (when distributed to shareholders)
  • Sub Chapter S
    • Advantages
      • Pass through entity (profits/losses not taxed at the business level)
    • Disadvantages
      • Ownership limited to 100 shareholders
      • Limits on who can be a shareholder
      • Only one class of stock allowed

I have only included high level information for each entity.  There are many variables involved in choosing an appropriate business entity, each of which is dependent on your specific situation.  If you have any questions about the choice of legal entity, or what is going on with your specific circumstance, feel free to give me a call or send me an email.