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Types of Business Entities – Pros and Cons

Choosing a business structure from the different types of business entities is an impactful choice which can have severe consequences. Weekly Investments will examine the different forms of businesses and the steps to set them up.

Sole Proprietorship – Types of Business Entities

A sole proprietorship is the simplest form of business structure. This business entity is set up when there is one owner which decides to have absolutely no distinction from the company’s assets and the assets belonging to the sole proprietor. Unless the owner is doing business under his or her personal name, a owner is likely to have to file a fictitious name document otherwise known as trade name or “Doing Business As” (DBA) name with the local county or state. Some advantages of sole proprietorships are that they are easy and inexpensive to form along with being accompanied by simple tax preparation due to taxes flowing straight through to the owner’s personal income. The single biggest drawback of a sole proprietorship is the unlimited liability of its owner. This means if the business has a lawsuit brought up against it, the entity or individual suing the business has the ability to come after the business owner’s personal assets.

Partnerships 

There are three types of partnerships: general, limited liability, and joint ventures.

General Partnerships – Types of Business Entities

This type of partnership is set up when all owners take equal responsibility of management, liabilities, and profits. If any of the partners are not equal, this must be clearly and accurately stated within the partnership agreement.

Limited Partnerships – Types of Business Entities

Limited Partnerships will have a general partner which is held accountable for the daily operations of the business and he/she also is burdened with unlimited liability. This type of  partnership will allow for some partners to be labeled as limited and maintain limited liability in the company. This is good if a general partner needs a capital investment but wants to maintain control of day-to-day operations. Imagine how difficult it would be to raise capital if all your potential investors had unlimited liability.

Joint Ventures – Types of Business Entities

This type of partnership is looked at like a general partnership but for a set duration of time such as a single project or one fiscal year.

 

Limited and General Partnerships require similar paperwork and are taxed similar to a sole proprietorship. The main difference between these partnerships and a sole proprietorship is the absolute necessity of drafting a solid partnership agreement. This should include plenty of “what ifs” within it such as what if a partner decides to leave or dies.

Corporations

C Corporation – Types of Business Entities

This is a legal structure that can be formed in order to limited its owners’ personal liabilities. C Corporations are the most common form of corporations in the US. A major advantage of a C Corporation vs a S Corporation (examined below) is that it has the ability to reinvest company profits at a low corporate tax rate.  The most significant disadvantage of a C Corporation is double taxation. Double taxation occurs when the C Corporation is taxed on company profits and then again on the dividends in which it distributes to its owners. If a C Corporation has more than ten million dollars in assets and five hundred shareholders which are not accredited investors, it must register with the SEC under the Securities Exchange Act of 1934. Becoming a C Corporation is an extremely time consuming and expensive process. As with all corporations, the company must file Articles of Incorporation with the Secretary of State in which it wants to incorporate in. Many companies establish as C Corporations in hopes to one day go public. Going public typically makes the shares of a business more liquid which means less risk for the shareholders; therefore, this tends to end up with the market putting a premium price tag on the business.

S Corporation – Types of Business Entities

An S Corporation has many of the same advantages as the C Corporation but differentiates itself by ridding itself of double taxation. S Corporations are pass through entities in which profits are passed through directly to shareholders and reported on their individual tax returns. The significant disadvantages of an S Corporation is its limited to 100 shareholders, it comes under much greater scrutiny than a LLC or Partnership, and is accompanied by substantial ongoing fees to keep the S Corporation status.

Limited Liability Company (LLC) – Types of Business Entities

LLCs are sort of a hybrid between a partnership and corporation. LLCs have the limited liability of a corporation with the tax advantage of a partnership. LLCs are typically much easier to form and inexpensive in comparison to a Corporation. The disadvantages of a LLC include the inability to issue stock, having to pay self-employment taxes, and lack of uniformity among states. A LLC can be formed by filing the appropriate Articles of Organization with your secretary of state.

Note: For all of these structures, the owner will want to make sure he or she applies for the proper business licenses and permits that are specific to the business’s industry and state. No matter what the structure, the organizer should apply for an Employer Identification Number (EIN) with the IRS. Even if you are only a sole proprietor with no plans to have any employees, this is good to have for personal security concerns. Many times working with suppliers, banks, or service firms, they will request your social security number; I have found most requesting agencies to typically accept an EIN number as an alternative to providing a social security number.

To learn more about decisions during a startup and the types of business entities visit our blog and/or visit the US Small Business Administration