Picking the Right Business Entity: The First Step to a Successful Business
The first – and perhaps most important – decision you will make when opening your own company is to select the proper business entity structure. Each entity structure has its pros and cons, so picking the right one for your business can be difficult. Working with a business law attorney can make the decision an easier one, but having a basic groundwork of knowledge about the different structures can also go a long way toward selecting the best formation entity for your business.
What Are the Different Types of Business Entities?
Traditionally, there have been a range of business entity selections, including small businesses (like family-owned businesses), sole proprietorships, partnerships, limited liability companies (LLCs) and corporations. Those same entity selections still exist today, but now there are variables – like the economic viability of a particular location, small business startup loans available only to women or minorities and veterans’ preference grants, to name a few – that might make one type of company more attractive than ever before. Knowing the essential elements of each form can help you make good decisions to get your company started on the right foot and have the best chance of success.
A limited liability company (LLC) is the most popular type of business entity in the country. This entity has both the tax benefits of a sole proprietorship or general partnership and the liability protections offered to a corporation. These businesses don’t have an independent tax liability; an LLC doesn’t pay taxes itself, but instead its tax deductions, credits and profits are filtered through the owners’ proportionate to their share in the company.
“Non-profit” business entities are, contrary to what some people may believe, not out to fail; despite the way it sounds, “non-profit” doesn’t mean that the company – typically a charitable organization, foundation, school, museum or otherwise philanthropic entity – isn’t attempting to make a profit. The “non-profit” moniker is used to describe the business’ tax status, not their philosophy. The difference between a standard business and a non-profit, though, is that the monies raised by a not-for-profit organization go to serve a purpose other than to make the shareholders wealthy; the funds instead go to further the needs of a recipient outside the organization.
S corporations are sometimes known as “small corporations,” since there are limits on the number of owners – no more than 100 individual owners can be named – that can have shares in the company. For ownership and reporting purposes, though, family members are counted as one owner, regardless of number, so a family of 200 people could theoretically still have 99 other partners to share ownership. There are residency restrictions on this type of business – no nonresident aliens or foreign nationals can have an ownership interest in this type of business, and it has fewer tax breaks than an LLC or sole proprietorship.
C Corporations are those that are owned by shareholders and run by a board of directors. C Corporations are popular business entities because they run a lower audit risk than some other types of businesses, expose the company’s leadership to a smaller risk of legal liability and can take advantage of special tax laws (like being able to deduct the cost of employee benefits and paying a lower tax rate than most individuals). They are also not subject to stockholder limitations like S Corporations and have no restrictions against foreign nationals having a stake in the business.
Partnerships are ideal for small business operations. This formation allows an existing relationship between two or more people who, according to the IRS, “carry on a trade or business” where “each person contributes money, property, labor or skill and expects to share in the profits and losses of the business.” These are ideal for protecting an owner from individual liability. Like an LLC, partnerships report profits or losses through the individual tax filings of its partners instead of having a collective tax burden. Unlike an LLC, though, a partnership has to file a yearly information report with the IRS that details the income, deductions, losses and gains of the business.
What’s Best for You?
Every person’s business circumstances are unique, so the decision must be given a great deal of thought. No matter what type of business entity you ultimately select, though, the decision is an important one that can be made easier with the guidance of an experienced attorney knowledgeable about the positives and negatives of each possible type.