There are many steps to incorporating a startup business, but one of the major ones is choosing the correct business entity. When you create a new business, one of the first things you choose is the type of business entity, as it determines your company’s legal and tax consequences.
A business entity in an organization created by an individual or a group of individuals to undertake their business activities and engage in trade or similar activities. Various entities offer different liability protections and offer protection for owners’ assets. Some common types of business entities are sole proprietorships, general partnerships, Limited partnerships, corporations, etc.
Let us now discuss each of these entities that entrepreneurs can choose from when starting a startup business.
Types Of Business Entities:
A business run by an individual is defined as a sole proprietorship. All firm payables originate from the sole proprietor’s accounts, and a sole proprietorship can be swiftly established in the owner’s name. Sole proprietorships are easy to set up and require minimal paperwork.
The main advantage of a sole proprietorship is that the proprietor is not answerable to anyone and is solely responsible for all startup business ideas.
In a sole proprietorship business, the owner takes the company’s liability from legal and financial aspects. It is also a risky alternative as the proprietor has to repay all the debts; in some cases, his personal assets are at stake if the business fails.
Partnerships are very similar to sole proprietorships. The main difference here is that the business has two or more owners. There are two types of collaborations, i.e., general partnership and limited partnership. In a general partnership, all partners are involved in the startup business ideas and have an equal share in profits and losses.
Starting a partnership is straightforward, as you are not required to register your business with the state. There are no corporate formalities or paperwork requirements such as meeting minutes, bylaws, etc. Owners get the benefit of deducting business losses from their tax returns. You don’t have to bear all the business losses alone, as they are divided between all the partners.
Partnerships are generally governed by a partnership agreement that specifies the rights and obligations of the parties involved. Here, the business capital is raised via the contributions of all partners.
A limited partnership, also called an LLP, is a partnership between 2 or more people wherein there is at least one general partner and one limited partner. The general partner oversees the business and is responsible for all business startup ideas and partnership debts, while the limited partner does not partake in day-to-day management activities. Limited partners have limited liability. They act as investors in the business and also pay fewer taxes.
Just like a general partnership, an LLP also requires registration. To form a limited partnership, you must file paperwork with the state. This business entity is mostly preferred by professionals like lawyers, accountants, architects, etc.
A limited partnership can serve as a good option for raising money. It is because the investors can act as limited partners without any personal liability. Limited partners can leave the business anytime without dissolving the business partnership.
Limited Liability Companies (LLC)
A limited liability company is a business entity that permits owners, partners, or shareholders to limit their liability and simultaneously have the flexibility of a partnership. This business entity provides a more formalized legal structure that separates the owner’s assets from the company’s debts.
In LLC, there is no limit to the number of members. The LLC and its members are generally governed by an operating agreement that is similar to a partnership agreement. The operating agreement clarifies the rights and obligations of the parties involved.
An LLC entity is advisable for a startup business where the company is in the development stage. This kind of entity gives you the advantage of attracting angel investors.
There are two types of limited liability companies, i.e., public and private.
Public Limited Liability Company
A Public LLC corporation trades publicly on the stock exchange, which requires public disclosure of their actual financial status to allow investors to determine their stock worth. Public LLC corporations are tightly regulated.
Shareholders here enjoy limited liability. In the case of court proceedings or bankruptcy, their obligations are limited to their investment. Shareholders have liquidity and can freely transfer their shares at any time.
Private Limited Liability Company
Private LLC businesses do not trade their stock publicly, so they are not regulated so strictly. Shareholders here enjoy limited liability and perpetual succession as the company is not tied to any person.
The number of shareholders here is limited to 50. Due to the lack of strict regulations, the management comes up with all the business startup ideas and conducts the business affairs more flexibly than in a public LLC.
Corporations are business entities that are separate from their owners and have their legal rights. A corporation has the authority to sue, own and sell the property and sell rights of ownership in the form of stocks. There are several types of corporations, i.e., C corporations, S corporations, and non-profit corporations.
In C corporations, the most common type of corporations, the owners receive the profits and are individually taxed. S corporations are similar to C corporations but have different owner limitations and tax structures. S corporations can have up to 100 shareholders, and these shareholders are personally taxed for their profits and losses. Non-profits are generally charitable and religious institutions that do not operate with a profit motive.
Corporations are pretty flexible when it comes to financing. Every corporation has to comply with state-specific laws. The corporation kind of entity is a good option for capital-intensive businesses because it helps receive a lot of funding from many different owners.
The same people who work with a cooperative (co-op) also own it. Its members or owners decide the organization’s mission, direction, and profits. Just like an LLC, co-op members have a limited liability for the business’s legal and financial debts and obligations. Co-ops do not tax their members on their income but tax the organization.
Forming a co-op is quite complex and requires you to choose a business name that indicates whether the co-op is a corporation (e.g., Inc or Ltd). The filing fee with a co-op agreement varies from state to state.
Your choice of business entity is of utmost importance. Whether you have a small business idea or planning for the next unicorn, your business entity selection will determine how people perceive your business. It also has a significant impact on your legal exposure and finances.
Sole proprietorship and general partnership are suitable for startup businesses. When your business moves to the development stage, it’s advisable to go for LLCs or corporations. You can take the help of a business lawyer and accountant while determining your business entity.
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