Selecting your business entity type is an important decision that should be made at the outset of your business activity and considered when certain changes occur (e.g., adding business partners or seeking investment).
The implications of different entity types may adversely affect your business if not properly considered. On the other side, key benefits and advantages may be available if certain actions are taken to establish your business type.
Fun fact: every business has an entity status by default.
- Do you run your own business? If so, you’re treated as a sole proprietorship.
- Do you have multiple owners? If so, you’re treated as a partnership.
- Each of these designations have different tax, legal, and operational differences.
It all boils down to Complexity vs. Liability.
A New Business Owner’s Guide to Entity Types
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Entity types which require a greater amount of complexity due to the requirements of state registration, legal documents, etc. also provide the greatest protection for an owner’s personal assets. Depending on the level of your business activity, these costs up front can pay off exponentially when personal protection from business debts and/or other owners is required.
A Limited Liability Company (“LLC”) is generally thought of as the simplest entity type that helps an owner separate personal liability from the business’s liabilities. LLC’s provide similar liability protection as a traditional corporation, however the setup costs are substantially lower.
LLC’s and Partnerships provide flexible ways for business owners to operate, however they are taxed very differently than most corporations. While corporations pay their own taxes, business income and losses of partnerships and LLC’s taxed as partnerships, are passed to their owners. The resulting income and losses are then taxable to the owners personally. Owners should be aware of these tax rules and plan accordingly.
Looking to raise money? Many investors and venture capitalists prefer the traditional corporate structure if they are making a significant investment. This is because the corporate entity type is less flexible and the investor can be confident in the rules and operation guidelines set forth. However this isn’t always the case as certain investors may seek out the specific advantages found in the partnership/LLC entity type such as flexibility and/or certain tax benefits. Understanding current owners’ and future investor’s goals will assist in deciding whether you have the optimal entity type.
Have questions about which entity to choose? Drop us a line.