When starting a business, one of the most important decisions an entrepreneur can make is which type of business to form. The most common types of entity are sole proprietorships, LLCs, LLPs (Learn about the difference between LLCs and LLPs here), C-Corps and S-Corps (Learn about the differences between S-Corps and LLCs here). Of course, a business may always be restructured later if the company needs to switch from one form to another, but getting it right from the beginning can save a person time, taxes and legal fees. In order to determine what business formation will best suit your company’s needs, it is important to consult with an experienced business attorney regarding the specifics of your situation, and Kalia Law P.C. is available to help. To get you started thinking about which business entity may be right for you, below is some basic information about the most common types used by small businesses and startups.
Sole proprietorships are the most simple business formation to create and may well be the most common. In fact, you may be a sole proprietor and not even be aware of it; if you conduct business for yourself selling a product or a service, you are already a sole proprietor. There is no filing requirement for a sole proprietorship, unless you are doing business under different name than your given name, in which case you need to file for a fictitious name or “doing-business-as” (DBA) certificate with the county in which you are based. While inexpensive and easy to form, a sole proprietorship is not a separate legal entity from its owner, meaning that the owner and the business do not need to file taxes separately and that there is no liability protection for the sole proprietor’s personal assets if the business gets sued.
A partnership is a business that two or more people own. General partnerships are the equivalent of sole proprietorships, in that there are few filing requirements and no liability protection, even for actions of the other partners. For this reason general partnerships are very risky. A safer form of partnership is a limited partnership, which is similar to a partnership but have increased filing requirements and limit the limited partners’ liability to the amount of their investment. However, these limited partners may not participate in the management of the business. General managing partners still have unlimited personal liability in a limited partnership.
Corporations are a common business form for companies that wish to have personal liability protection for owners. Corporations are popular choices for startups that wish to attract investors and share ownership by selling shares or ownership stakes in the company. Corporations provide the strongest shield against personal liability for its shareholders and directors, especially when appropriate shareholders agreements are in place (learn more about shareholders’ agreements here). The main disadvantages to forming a corporation are the formalities required, meaning that there are extensive filing and record-keeping requirements, as well as operating requirements such as the election of a Board of Directors, the adoption of bylaws (learn more about corporate bylaws here), among others. Depending on the type of corporation formed (S or C), a corporation may be taxed as a separate entity from its shareholders or be a pass-through entity, like a partnership.
Limited Liability Companies (LLCs)
Relatively new to the business entity scene, LLCs are a hybrid between partnerships and corporations, and attempt to combine the liability shield of a corporation with the flexibility offered by partnerships. Members of LLCs may be individuals or other LLCs, and may participate in the management of the company while maintaining liability protection. In addition, LLCs may elect to be taxed as a corporation or as a pass-through entity, making it one of the most flexible business forms for tax purposes. LLCs are relatively easy to form, and usually are not subject to stringent filing requirements. Another aspect of LLCs that is attractive to small business is the fact that they allow for flexibility for distributions and allocation of cash and other assets.
The Bottom Line: Consult an Attorney
The choice of a business entity is very important in starting a business and can have implications on the way you are taxed and your personal liability for business debts and liabilities. Each of these business types has different advantages and disadvantages, and the one that is right for you is largely dependent on the specific circumstances of your situation. In order to determine which entity would best suit you needs, it is best to discuss your options with an attorney who specializes in the issues that are most likely to affect small business.