When starting a small business there are many decisions to be made.  One decision is which type of entity to establish. This is a decision that should be taken seriously as there are very real legal and financial implications involved.  The type of business entity chosen will determine many factors including: the amount of taxes you must pay, how easy it is to get a small business loan or money from investors and what assets can be collected if the business is sued.  

Let’s look at the most common entities:

  • Sole Proprietorship: This is the simplest structure and most common form of business organization. One person, the owner, is responsible for all financial obligations of the business. The businesses income and expenses are included on the owner’s personal taxes which can be good or bad.  Business losses suffered can help offset income earned from other sources but if there is no other income to offset, you are personally responsible for the company’s liabilities. It can be difficult to raise money in a sole proprietorship leaving you to depend on your own financial sources. This type of entity does not need to be registered with the state but depending on the industry local permits or licenses may be required.  
  • Partnership: An entity owned by two or more individuals who agree to share in the profits or losses of the business. There are two different types of partnerships: general and limited. In a general partnership, all is shared equally.  In a limited partnership, general partners have control of the business’s operation and assume liability while limited partners serve as investors only.  The profits and losses of the partnership are reported on the partner’s individual income tax returns, which is an advantage for the business but holds each partner liable for the financial obligations. Partnerships are more expensive to establish than sole proprietorships since they require more extensive legal and accounting services.  
  • Corporation: A corporation is an independent legal entity that is separate from those who founded it.  This type of business structure is more complex and expensive than the others. Much of the cost is from forming the corporation and the requirement of extensive record keeping, likely requiring professional assistance.  A corporation has its own legal rights and can be taxed and held legally liable for its actions. The biggest benefit is the avoidance of personal liability, refraining from personal assets being at risk if the company goes downhill. Corporations can keep some of its profits without requiring the owner to pay taxes on them.  One downfall is that corporations are subject to double tax on the business’s earnings.
  • LLC: A limited liability company (hybrid structure of partnership) allows owners, partners or shareholders to limit their personal liabilities while allowing profits and losses to be passed through to them without taxation of the business itself. The owner has the choice as to whether he/she wants the LLC to be taxed as a partnership or corporation.  An LLC does require registration with the state which makes it more expensive than creating a sole proprietorship or partnership. This type of entity is popular among small business owners since they combine the ease of a sole proprietorship with the legal protection of a corporation.

Choosing a business entity is not a decision to be taken lightly.  The unique needs of the business and its owners should be carefully considered when making such a big decision.  Seeking advice from an experienced business attorney would be a great way to learn which entity would be the best fit for you. We at Thornton Law Firm would be happy to assist in offering professional advice on which structure is best for you and your business.