Choosing the Right Business Entity
As an entrepreneur it is critical to understand the intricacies of business entities and to know which type of business entity to choose for your business. The steps that you take to raise and solicit funds, to avoid needless taxation and to run your business efficiently depend on choosing the best business entity. Choosing the wrong legal entity can create deal-breaking liabilities for your budding business, so don't tread lightly on this choice.
Some businesses must be registered with the state and meet certain legal requirements, while others just need a name and can start operating immediately. To help you choose a legal entity for your business, we have given an outline of the various types of businesses. Read on the article to know the differences between different businesses and get some idea about the business entity that you would opt for in the future:
This means you are the only owner of your business. Basically, you started the company and all the company payables are met from your personal expenses. The arrangement is a simple one, but it has many disadvantages. By mingling your personal expenses with the professional ones, you become solely responsible for any financial issues related to your business. This sort of a ‘simple arrangement’ can become complicated at payroll time or when your company faces a lawsuit. Due to these uncertainties, many sole proprietors opt to file for a DBA, which means “doing business as”. A DBA is required for marketing purpose. It basically puts a professional façade on your sole proprietorship, but offers no legal protections.
A partnership can be between 2 people or 20 people where each one is contractually bound to contribute money, goods or services to a common fund and agree that profits must be shared between the partners as stated in the contract. On dissolution of a Partnership, the assets are liquidated and the creditors are paid. However, like a sole proprietorship, a partnership does not have any limitation of liability. Further, in states that recognize joint and several liability, you can actually be held liable for the mistakes of your partners, even if you did not know about them.
In limited partnership, the partners are responsible for the business, but investors can opt to be limited partners Limited partners are not rooted in a business as general partners, so the worst financial trouble that they can face is losing their original investment. Most entrepreneurs do not prefer this kind of a business entity because this form of partnership does not provide built-in protection for entrepreneurs.
LLC or Limited Liability Companies
These companies have a more stable and formalized legal structure that offers adequate protection from liability compared to a partnership. This particular business entity is preferred by most entrepreneurs because this structure enables them to separate their personal assets from company debts in a simple manner. LLCs operate from LLC Agreements or Operating Agreements, which are agreed upon by the LLC's members that dictate the management of the LLC. Limited Liability Companies do not hold annual meetings, record meetings or have boards. In a Limited Liability Company, there is no member limitation and the ownership can be classified to offer some flexibility to entrepreneurs when it comes to raising equity financing. This entity makes sense if your business is still in the developing stage as it may attract more angel investors.
It is always better to opt for a C-Corp if you are on the early stages of developing your business and have set your eyes on venture capital. Usually VCs or venture capitalists prefer investing in this type of a company. In this business entity, debts, tax and the legal structure are separated from your personal assets and taxed as a separate entity. Holding annual meetings and recording minutes are important responsibilities of a C Corp. The only disadvantage is the C Corp is taxed on the corporate profits.
An S-Corporation is a C-Corporation that elects to be treated as a pass-through entity. Legally, it is no different from a C-Corp except in how it is taxed. An S-Corporation would be a great option if you are comfortable with limiting the number of shareholders and need liability protection. The S-Corporation offers many tax benefits over other entities. If you are looking for venture capital investment, then S-corps are not ideal because you’ll be limited to one class of stock that would remove your chances to do multiple rounds of financing.
This is only a brief overview of the many types of business entities for small business.
If you want to know more about the options for a legal entity for your small businesses, get in touch with the professionals at Watson Firm. Just call 205.545.7278 or complete the form on this page to get started now!