Choosing The Right Entity
April 16, 2012 | By Vela Wood
Choosing the right type of entity for your startup is very important and something you should likely discuss with an attorney. There are four general entity types to choose from, each with its own particular advantages and disadvantages.
Entity 1: Sole Proprietorships
A/K/A the “Default” option. A lot of times entrepreneurs will start their business without having set up an entity. This puts them into the default, easy to create, sole proprietorship. The advantage to sole proprietorship is the simple tax structure, which only requires reporting of profits and losses through the owner’s personal tax return. The disadvantage is that the businesses’ assets/debts are tied to the owner’s personal property.
Entity 2: Partnerships
A/K/A the “Sharing the Risk/Reward” option. Similar to the Sole Proprietorship, but you’re working with someone else on the business. Like the sole proprietorship, a partnership will tie the business and personal assets of the partners together. This may lower the individual personal liability of each owner, but each partner is responsible for the others’ debts to the partnership. The advantage — like the sole proprietorship — is the simple tax structure. The disadvantages include issues of idea ownership and the ease with which disputes between the partners sometimes raise their ugly heads and lead to a messy dissolution.
Entity 3: Corporations
A/K/A the “Here we come NYSE” option. The most costly and time intensive entity type, also offers the most personal asset protection. This entity type creates a completely separate entity apart for the owners (shareholders). This complicates tax matters and creates “double-taxation” issues (taxes paid by the corporation and then again on the distributions paid to shareholders). The corporation holds the property/assets of the company and shields the owner’s (shareholders) personal property from debts incurred by the company.
Entity 4: Limited Liability Company
A/K/A the “Best of Both Worlds” option. An LLC gives owners the option of being taxed like a Corporation or being taxed like a sole proprietorship/partnership. This entity type also offers personal asset protection in the event the business fails. The advantage of the LLC is, as the new kid on the block, that it offers many small businesses the asset protection and tax benefits they require. The disadvantage is that if the business takes off, the LLC will want to transition to a C-corp to accept larger investment/shareholder opportunities.
Before selecting any one of these entity types you will want to talk about your business objectives with an attorney and accountant to ensure you are best protecting your interests.