Startup businesses often ask: Which entity should I choose? Indeed, choice of entity is a fundamental principle in startup law and one of the most important decisions a founder will make. The difference between starting a company that may potentially go IPO and managing a bakery is huge. Well, the only answer to the question above is to choose a formation that meets your needs. Here, we want to discuss the pros and cons of some of the most common types of entities.
A sole proprietorship is the most convenient way for you to start a business by yourself. You only need to fill out some simple government forms. You can make flexible changes to your business without the approval of others. There is no legal distinction between the owner and the business entity, which means you receive all profits.
On the flip side, you are also personally liable for all losses and debts. This type of business may suit the needs of people who want to have everything related to their business attached to them, as an individual, and under their control. A unique style local coffee shop, restaurant, or other small business may be good examples. It’s certainly the lowest cost way to start your own business but is also very risky (think: what if someone falls and hurts themself in your coffee shop?).
General Partnership (GP)
Compared to working as a sole proprietor on your own, you can benefit from companionship and mutual support when working in a business partnership. In a General Partnership, you and your partners share the management of a business, and each partner is personally liable for all debts and obligations incurred by other partners. This means that even if you have no faults in operating the business, you might have to settle 100% of the partnership debts when the other partners have no assets.
Limited Liability Partnership (LLP)
A limited liability partnership can help you avoid the pitfalls mentioned above. An LLP is a partnership in which you are not liable for the malpractice of other partners, but you are personally liable for obligations to business creditors, landlords, and lenders. Similarly to a GP, you take a share of loss or gain on your income taxes. You should know that not every state recognizes LLPs. Some states limit the creation of LLPs to professionals such as doctors or lawyers.
A C-corporation is the most typical business formation. As a C-corporation owner, you can enjoy limited liability protection from the debts, judgments, and other obligations of the company. You could get certain benefits of deduction as business expenses with good accounting. If you plan to pursue an IPO or acquisition someday, the C-corporation is your best choice.
The main disadvantage is the so-called “double-tax.” The corporation itself is taxed for any profits earned, and any individual stockholder who earns profits in the form of dividends from the corporation is also taxed. If you have such concerns, you have an option to establish an S-corporation.
S-corporations enjoy most of the benefits of C-corporations. The primary advantage of an S-corporation is that the company does not need to pay income tax itself. To be granted the S-corporation designation, your business must first be set up as a C-corporation.
There are several requirements a company must meet to be granted the S-corporation designation. For example, it must be a domestic corporation, it can only have a limited number of shareholders, and it can only have one class of stock. Most importantly, all shareholders must be U.S. citizens or lawful permanent residents and not other corporations or LLCs. An S-corp is not a good choice for IPO or acquisition due to some of these restrictions.
Limited Liability Company (LLC)
The LLC is a newer type of company compared with a traditional corporation. LLCs come with a more flexible management structure and membership criteria. Members can be individuals, partnerships, trusts, or corporations, and there is no limit on the number of members. With the advantages of limited liability and no restriction on ownership, the formation and ownership are less stringent than with C-corporation and S-corporation. Moreover, the transfer of ownership for an LLC is more complicated than that of other entities.
You should also notice that some states have requirements that LLCs should have more than one member. In comparison with a Sole Proprietorship, an LLC is relatively cheap and easy to set up, yet can protect small business owners from unlimited personal liability. This makes it an excellent choice for small business owners who want to enjoy the protection of a company formation.
Professional Limited Liability Company（PLLC）
In many states, professionals whose jobs require licensing by the state are not allowed to form an LLC. Pursuant to that restriction, they must form a PLLC instead. PLLC has the advantages of an LLC such as protection from personal liability, perpetual existence, and the ability to choose how the LLC will be taxed (either as a partnership or a corporation). Similarly to an LLC, all members of a PLLC must belong to the same profession.
We hope to help you weigh the complexities of the different kinds of company formation by simplifying the categories into a graph.
Starting a business? Find a lawyer to help you decide which entity best suits your situation: https://www.sleegal.com
*The information provided on this website does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this site are for general informational purposes only.