Types of Business Entities
Businesses can operate in a variety of structures, such as a sole proprietorship, partnership, limited partnership, corporation, or limited liability company. Each of these forms of incorporation provides certain benefits and also certain limitations. The legal structure of a business determines how it is managed, how it is taxed, and what regulations it must follow.
So how do you know what form of entity is the right one for your business? Things to take into consideration include:
- Company Size – Do you plan on keeping your business small or do you plan on expanding by adding employees and locations? How many existing employees do you currently have and how many owners will there be, does every owner own an equal share? Some corporate structures require additional formalities. For instance the corporate form requires a board of directors, annual meetings, shareholder approval, etc. Smaller companies may consider more flexible forms of business, such as an LLC or even a sole proprietorship.
- Business Purpose – Will your business make and sell a product or will you provide a service? Some states only allow personal services providers to register as LLCs or LLPs.
- Liability – Some forms of doing business offer the protection of limited liability, which means the owners are not personally responsible for the debts of the business. Business structures offering limited liability protection include corporations, limited liability companies (LLCs) and limited liability partnerships (LLPs). Sole proprietorships and partnerships do not have limited liability.
- Taxes – Profits and losses for businesses are treated differently for each type of business entity. Profits from sole proprietorships and partnerships pass through to the owners and are treated as personal income. This means the profits are taxed one time. Profits from corporations and limited liability companies do not necessarily go directly to the owners, but are taxed when the company distributes dividends to the owners. There are some exceptions and alternatives depending on the entity structure.
The main types of business entities are:
- A Sole Proprietorship is a business which is completely owned by one person and which the business does not have a separate legal identity. The owner personally owns all of the assets and profits and may not be required to register with the state.
- A Partnership is a business that has two or more owners who agree to share the profits and has not formally registered as a corporation, LLC or other entity type. The general rule in a partnership is that each partner owns an equal share of the business unless there is a written partnership agreement giving one of the partners a majority interest. In most states formal steps may not be required to create a partnership, but complying with certain formalities is usually recommended.
- A Limited Liability Partnership (LLP) is a business that is organized and run just like a partnership but limits the liability of each partner. Some states only allow licensed professionals to form an LLP, like architects, accountants or lawyers while other states allow anyone to form an LLP. Most states require LLPs to register and pay a registration fee, and include “limited liability partnership” or “LLP” in the business name.
- A Corporation is a business that has a separate identity from its shareholders, and may be organized for any business purpose. The general requirements are that there must be at least one shareholder and the corporation must have a director(s), president, secretary, and treasurer, though in some states the same person may hold all of those positions. Unlike a partnership or sole proprietorship, a corporation continues to exist even when its ownership changes hands.
- A Limited Liability Company (LLC) is a hybrid of a corporation and a partnership. Unlike a corporation the owners of an LLC are called members, and LLCs. LLCs offer limited liability, while requiring fewer formalities than a corporation. Other features which may be provided for include continuity of life if a member dies or sells their interest, centralization of management, and free transferability of an owner’s shares.
About the Author
Attorney Steven Peck has been practicing law since 1981. A former successful business owner, Mr. Peck initially focused his legal career on business law. Within the first three years, after some colleagues and friend’s parents endured nursing home neglect and elder abuse, he continued his education to begin practicing elder law and nursing home abuse law.