The most important step an individual takes when starting a business is selecting the type of business entity. A wide range of options are available for new business owners. These include a partnership, a limited liability company (LLC), a sole proprietorship, or a corporation (Franklin, 2016). Each entity has different set of legal and tax implications. When choosing the type of business entity, it is important to factor in the long-term and short-term goals of the business. Apart from identifying the long-term business goals, the owner has to consider a wide range of legal and tax considerations. There are also subclasses in different types of business structures. For instance, a corporation may be a C corporation, an S corporation, or a professional corporation (Franklin, 2016). Overall, choosing the right business structure requires an in depth analysis of the different options and a consideration of the legal implications.
For business owners who enjoy autonomy, a sole proprietorship may be the ideal choice. A sole proprietorship has a simple and straight forward structure that can be operated by a single person. Unlike other business entities, a sole proprietorship is not recognized by law as a separate business entity. As such, the person who owns the business is also responsible for its debts and liabilities. For instance, if a person sues a sole proprietorship, the person is personally responsible for any legal obligations that may arise from the suit (Meyer, 2015). A sole proprietor can also operate the business under his own name or under a fictitious trade name. However, the trade name is only used as a trade name not a legal entity that is separate from the person.
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Sole proprietorships are one of the most common business structures. This is primarily because of the simplicity in the operation and management of a sole proprietorship both in legal and in operational terms. Sole proprietorships are also common because they are less costly to set up. For example, to get a sole proprietorship business running, a person only needs to register his or her name. The owner of a sole proprietorship also enjoys all the profits of the business and usually faces no challenges that comes with dealing with partners.
The biggest disadvantage of a sole proprietorship is the level of liability. Sole proprietorships have unlimited liability (Meyer, 2015). Owners of sole proprietorships are fully liable for the financial position of the business and normally file tax returns that incorporate the financials of the business. Owners of sole proprietorship may also experience challenges when trying to raise capital as there is lack of business continuity.
Individuals starting businesses also have the option of forming partnerships. A partnership is a business entity that is formed when two or more individuals engage in a profit making activity. Partnerships can either be formed through a legal agreement or a through a gentleman’s agreement. Most partnerships are usually formed accidentally through oral but legally binding agreements. As such, most partnerships result in disputes and lawsuits between the business owners (Meyer, 2015). There are a wide range of advantages associated with partnerships. Like a sole proprietorships, partners can start partnerships with relative ease. Starting a partnership is also very affordable. Unlike corporations, partnerships enjoy a favorable form of taxation and are not required to go through formalities such as annual meetings. Partnership are also not required to remit minimum taxes like corporations and limited liability companies.
The biggest disadvantage of a partnership is the absence of liability protection. Like in a sole proprietorship, individuals engaged in partnerships have unlimited liability in regards to the debts and liabilities incurred during operation. However, unlimited liability does not apply to individuals in limited partnerships and limited liability partnerships. Another disadvantage of a partnership is that legal liability of individual partners extend to other partners. Because of the concept of unlimited liability, most legal experts do not recommend starting a partnership as a business entity.
Individuals starting a business may also choose to start a limited liability company, commonly referred as an LLC. An LLC is a type of entity that provides the flexibility of a partnership and incorporates features of a corporation. An LLC consists of members that enjoy limited liability protection from financial obligations. Members of an LLC are also allowed to divide the profits and losses of a company in whichever way they choose. This is regardless of the ownership percentage of the members. The biggest advantages of an LLC emanate from its simplicity and flexibility (Franklin, 2016). LLC are not legally required to hold annual meetings and are bound by few legal formalities. Owners in LLCs are also protected from legal liability as the LLC exists as a separate entity. Like partnerships, LLCs also enjoy favorable modes of taxation. However, LLCs are costly to form and to operate as they are subject to annual legal fees. Moreover, LLCs are legally required to submit periodic filings to the state. LLCs may not be ideal for individuals seeking to raise funds through financial markets. Unlike a corporation, an LLC cannot issue common stock.
Lastly, individuals starting a business can form a corporation. Corporations exist as separate legal entities. As such, owners of corporations enjoy limited liability. As a separate legal body, a corporation can be sued, transact property, and has tax obligations. The biggest advantage of a corporation is that owners are protected from legal liability (Franklin, 2016). Corporations also have perpetual life. This means that shareholders can pass ownership to other people when they leave the corporation. Corporations are also ideal for raising capital as they are able to issue shares. However, corporations are required to follow strict formalities and are expensive to set up compared to LLCs or partnerships. Overall, if I were to set up a business I would choose to start a corporation. Among other structural benefits, a corporation would allow me to effectively raise capital from a wide range of available financial markets.
References
Franklin, E. (2016). A Rational Approach to Business Entity Choice. Kansas Law Review . doi: 10.17161/1808.25508
Meyer, C. (2015). How to help clients pick the best entity for their business. Retrieved from https://www.journalofaccountancy.com/newsletters/2015/aug/help-clients-pick-best-entity.html
