When starting a business, one of the first, and most important decisions the owner or owners will need to make is choosing what type of corporate entity to form. The type of corporate entity you choose will impact how much you pay in taxes, your ability to raise money for the business, the paperwork you will need to file for the business every year, the personal liability of the owners, costs associated with forming and operating the business, and even how the corporation is dissolved. Choosing the wrong type of corporate entity could cost business owners substantial time and money every year for the entire life of the company and can even impact an owners personal assets. Accordingly, it is very important that potential business owners fully understand the advantages and disadvantages to each type of business entity before making their choice.
The four most common types of corporate entity’s are: Sole Proprietorships, Partnerships, Corporations and Limited Liability Companies (LLC’s). Some of the advantages and disadvantages of the different types are discussed below.
The most common and most simple type of business ownership is a sole proprietorship. A sole proprietorship is owned and run by someone for their own benefit. This type of corporation is regulated very little, owners have total flexibility with how the business is run and they very cheap to start. However, the owner of a sole proprietorship is 100% liable for the debts of the business meaning that the personal property of the owner is not safe from creditors of the business.
Partnerships are like sole proprietorships but for more than one owner. There are two types of partnerships: general and limited. In general partnerships, both owners invest their money, property, labor, etc. to the business and are both 100% liable for business debts. In other words, even if you invest a little into a general partnership, you are still potentially responsible for all its debt. Limited partnerships let the partners limit their responsibility for the debts to the percentage of ownership or investment in the company but, like sole proprietorships personal property of the owners is not shielded from creditors. Corporations are also more expensive to form and run.
Corporations are different from sole proprietorships and partnerships in that corporations are treated like a separate entity for tax purposes and with regards to the liabilities of the owners. This provides a shield for owners from creditors of the business – but not without a cost. Since corporations are thought of as separate entities, the corporation has to pay taxes on the income of the business and then each owner has to pay separate taxes on any income they receive from the company so essentially the income is being taxed twice.
A limited liability company (LLC) is like a mix of the above-mentioned types. In LLC’s, the liability to the company owners for debts or losses is limited and the profits are not taxed twice in a Corporation. However, LLC’s require comprehensive and sometimes complex agreement between owners and there are high fees associated with forming an LLC.
The difference between each of these and other types of entities not mentioned here are somewhat complex and the right one for your business depends on many different factors such as: your vision regarding the size and nature of your business, the level of control you wish to have, the level of “structure” you are willing to deal with, the business’s vulnerability to lawsuits, tax implications of the different organizational structures and expected profit (or loss) of the business. It is very important to consider all of these factors when choosing what type of entity to form for your business.
The Choi Law Group, LLC provides legal advice and assistance in all areas of business law including: corporate formation and dissolution, annual reports, and business operations. The attorneys here have experience in organizing corporations for various types of businesses and can make sure you understand the differences and that you are considering all the appropriate factors before making your decision.
Written by Richard W. Hawkins, Esq.