Business Entity Formation
When it comes to selecting the right legal structure for your business, it all starts with a careful assessment of your company's goals, objectives, and a thorough analysis of relevant laws at the local, state, and federal levels. This initial identification process is crucial as it helps prevent potential issues that may conflict with your company's mission and impede its growth. It's important to note that as your business needs evolve, your legal structure should also be adaptable to accommodate these changes. To assist you in making an informed decision, here are some common business entity types and factors to consider when determining the appropriate legal structure for your business.
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By: Nnamdi Nwaneri (04/2021)
Types of Business Structures
Corporation
A corporation as an entity separate from its ownership group, having its own set of legal rights such as the ability to sue, be sued, issues ownership sales in the form of stocks, and own/sell its property. There are several classifications most notably S corporations, C corporations, closed corporations, and nonprofit corporations.
S corporations are ordinary business corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. C corporations are owned by an unlimited number of investors/shareholders and are taxed as separately from the entity. Closed corporations are generally operated by a select number of shareholders and are not publicly traded. A nonprofit corporation is an organization formed to serve the public good rather than purely for the creation of profits itself, receiving certain tax exemptions as rewards for its commitment to public service. Advantages in corporations include limited liability against the corporation and indefinite business operational continuity.
Partnership
In a partnership two or more individuals own the entity. There are two classifications: general partnership and limited partnership. In a general partnership, profits and losses are shared equally amongst the partners. In a limited partnership, one of the partners has operation control while the other partners contribute to and receive part of the profits and are still responsible for losses. Depending on the entity’s funding and liability structure, partnerships may serve as a sole proprietorship or as a limited liability partnership; this is known as a dual status. Advantages of partnerships include multiple owners for workload sharing and collaboration, pass-thru taxation for profits and losses onto the partners’ individual income tax returns, and easy formational setup and registration. A skilled attorney should draft a partnership agreement.
Limited Liability Company
A limited liability company is a hybrid structure between a corporation and a partnership where that partners or shareholders may limit their personal liabilities from the company while also benefiting from the tax structure of a partnership. Limited liability companies can have multiple members and profits and losses may be divided in a manner determined by the members. Personal liability from company debt is shielded if the company does not act in an illegal manner in carrying out business activities. There are associated state and local filing fees in forming a limited liability company along with annual assessment fees.
Sole Proprietorship
In a sole proprietorship one person is responsible for the entire company’s assets, liabilities, and equity. The one person does not have the liberty to separate their personal assets from the company. Advantages in sole proprietorship include low cost administrative fees, tax deductions, and easy formational setup and dissolution, as one person is involved.
Factors to Consider When Choosing a Business Structure
Capital Investment
Some investors require a certain type of entity formation before procuring funding. Additionally, certain entities are able to secure funding by selling shares while others are not. The appropriate legal structure will make this undertaking more manageable.
Taxes
Each entity is taxed a certain way thus proper analysis on whether pass-thru taxation, double taxation or the like is appropriate for your company is need.
Complexity
As mentioned some entities require paperwork, licenses or adherence to regulations by state or federal governments while others require little to zero before operating.
Control
The number of chefs in a kitchen at times determines whether the meal is a delicacy or a disaster. Similarly with entity formation, the number of partners, shareholder, or owners could determine the success of a company.
Flexibility
Growth should be a consideration during entity formation. The rate and scope of growth varies per company but how your company grows in relation to its initial legal structure is a crucial factor as to prevent future hindrances.
Liability
Depending on your entity function, you likely want the least amount of personal liability meaning access to your personal finances by creditors and potential litigants.