Types of Business Entities
When it comes to starting a business, there are a lot of decisions to make. What type of business should you form? What’s the best way to structure your company? How can you minimize your taxes and maximize your profits?
We always recommend that you have a good accountant or CPA to help you through this, but have an overview of some of the most common types of business entities to help you make an informed decision about which is right for you. We have also included what a banker might want to know to help you open an account or get a loan for the business, and the legal documents generally required to start each type of entity. Banks are always going to want you to have a business license for the entity, so be sure you have that ready to go.
The sole proprietorship is the simplest and most common structure to start a business. With this type of unincorporated company, you are entitled to all profits but must shoulder any debts or losses. Banks will want the business license even for a sole proprietor, and if you are using a “Doing Business As” name, that name should be listed with the State. This will allow you to deposit checks that are made out to the business name.
Partnerships are like sole proprietorships that don’t require establishing a legal entity. The owners of the partnership share resources and work together to start their business. However, they do not form an incorporated company with shares. In this situation, you will want to have a partnership agreement that outlines who owns what portion of the business, how you split responsibilities and income, and what would happen if the partnership were to dissolve.
Limited Liability Company
Limited Liability Companies (LLCs) are a type of business structure allowed by state statute. Each state has different regulations, so confirm eligibility. LLC owners are called members, including individuals, corporations, other LLCs, or foreign entities. LLCs can protect members from personal liability concerning legal actions or business debts. Profits and losses pass through an LLC without being subject to corporate taxes. Many states do not require a full LLC Operating Agreement, but most banks will want to see one and you should have one for your own protection. This agreement tells you who manages the business, what percentage each manager will own, as well as what happens if a manager leaves or the LLC is dissolved.
S corporations are an excellent way for business owners to eliminate double taxation on their profits. Shareholders of these firms report the flow-through of income and losses at the individual level instead of at the business level, avoiding double taxation. This entity is a corporation and you will want to have articles of incorporation and bylaws that define not only the purpose of the business, but also how business will be conducted, how shareholders can sell their shares, and who handles what decisions. Bylaws are the internal rules of the company.
A Corporation offers the most protection from personal liability; however, it requires more time and money to establish than other structures, such as partnerships or LLCs. An S Corporation is a separate legal entity owned by shareholders. C Corps are generally organized for larger businesses that have a complex operating system. Like an S Corp, you will need articles of incorporation, bylaws, as well as minutes of an organizational meeting, information about shareholders, and shareholder agreements.
As with most things, there are pros and cons to each type of entity. Talk to an accountant to see which option works best for you and your business. You can also visit Business Structures | Internal Revenue Service (irs.gov) to learn more about each entity type.