Selecting The Proper Entity
Selecting The Proper Entity
The combination of limited liability, tax benefits, and less ongoing administration makes LLCs an attractive option for most small businesses.
You hear it all the time: make sure you select the proper entity when starting a new business. But what does that mean? And shouldn’t you just go with an LLC?Companies can take on a variety of forms, each with its own requirements as well as pros and cons. It is absolutely crucial that you plan ahead to select the best entity for you. This is even more true if you have more than one founder. It can be difficult, expensive, and time-consuming to change your entity after you are up and running. Ok, there are different entities, but what are they? While there are a number of different versions of the major entities, we are going to focus on the broad strokes today. For our purposes, there are four major kinds of for-profit entities: sole proprietorships, partnerships, limited liability companies, and corporations. You will almost certainly end up as one of those four.
Sole props (as they are often called) are pretty much what they sound like – a single person entity. As a sole proprietor you will not have any real liability protection but you will have less filing requirements and positive tax advantages. A sole proprietorship that does not go by your name (for example, John Smith, Accountant vs. Smith and Smith, Accountants) requires you to file an assumed name certificate with your Secretary of State. Because of the lack of liability protection, their limits on the number of founders and investors involved, and the complications that often arise from co-mingling personal and business funds – sole proprietorships are only appropriate for a limited number of ventures.
Yet again, partnerships are what they sound like – a multi-person entity built of individual partners. General partnerships, as opposed to limited partnerships, do not provide the liability protection of other entities but they do provide some tax advantages. In the most basic of cases, each partner contributes their money, property, labor, or skill to the business and each partner shares in the profits and losses. Accordingly, partnerships are not taxed as a distinct entity but instead file an annual information form. Partners include their respective share of partnership profits or losses on their personal tax returns. Because partnerships, by their very nature, involve multiple people it is important to make sure that you work with an attorney to draft a partnership agreement. Partnerships are more common in cases of short-eterm projects and joint ventures. In many cases, the limited liability company has supplanted the partnership as a preferred business entity.
Limited Liability Companies
Here we go – the big fish in our small pond. Limited liability companies provide the limited liability (obviously) that new business owners are looking for. In some cases it can also provide the pass-through tax benefits of sole props and partnerships. Unlike corporations, LLCs are not taxed as a separate entity and all profits and losses are passed through to each member. LLCs are a flexible entity that allow for their members to manage them or to have a manger manage the company. Through the use of an Operating Agreement you can make them fit a variety of setups and situations as well. They also have less administrative requirements than corporations do. The combination of easy setup, tax benefits, limited liability, and less ongoing administration makes LLCs an attractive option for most small businesses.
Corporations are people too! It’s a common political refrain these days, and it has a basis in the law. A corporation is treated as a separate entity from its shareholders. It acts in its own name and is taxed as its own entity. In addition to shareholders, it has a board of directors and officers. Most major companies you can think of are corporations. Since it is treated as distinct from its shareholders, it also has limited liability protection. Corporations have the most administrative requirements and also pose the threat of double-taxation since they are taxed and shareholders are later taxes on their dividends and/or capital gains. In exchange for these cons, corporations also allow the most possibilities when it comes to investment and future financing. Corporations are best for larger companies with multiple employees and for companies that someday hope to grow. Similarly, corporations are often the preferred vehicle for startups that seek to traditional rounds of venture capital and/or make an initial public offering down the road.
So there you have it, a quick introduction to the major types of business entities. An introduction is obviously a lot easier than structuring them to meet individual needs – for that, you should talk to an attorney. If we can ever help, feel free to contact us.