How To Choose A Legal Entity
Question: What entity sounds like it fits your business best?
Choosing the correct legal entity for a business can be very intimidating for someone who has never started one before. My goal is that, after you finish this article, it won’t be. I think one of the reasons it’s so intimidating is because there is so much information on the subject out there and how people present that information: They either say “talk to an accountant or attorney,” or they list the myriad features of each. I would like to take a different approach.
I would like to describe your situation, as if I were there with you, and tell you which entity you should choose. I will start with the legal entity, and describe why you would most likely pick this one. If it sounds like I’m describing you, then that’s your best bet. I’ll go in order of most likely/recommended (for a small business) to least.
One last thing to cover are a few definitions, so the below makes sense:
Limited Liability – this means that your personal assets are not at risk of paying for business losses or obligations. The assets under the business entity are still at risk.
IPO – this stands for initial public offering, and it refers to the first time that a business makes its shares available for the public to purchase. There are many more regulations that appear at this stage of the game.
Limited Liability Company – You are starting a business by yourself or with other people. You are willing to pay a little money and do a little work to get the benefits of limited liability. This is usually a good choice.
Sole Proprietorship – It’s just going to be you in this business for the foreseeable future, and you see very little risk of liability. You just want to start making money on something you’re already making or doing.
Professional S-Corporation – You are starting with another person or people, and you think there will be significant profit at the onset. You’re willing to pay more and do more to set it up to enjoy better tax treatment.
General Partnership – It’s going to be you and another person or people, but you see little risk of liability. You want to minimize the cost and effort of setting it up. This is similar to a sole proprietorship, except with other people.
Limited Liability Partnership – This is similar to the general partnership, except that you have one or more partners that just want to invest money in the business and not have any control. They will benefit from limited liability, while the general partners will not.
Professional C-Corporation – C-corps were much more common before LLCs were available. Now, one of the biggest reasons to use one would be if you intended to do an IPO. Even then, you may want to consider another way of selling shares for money to avoid a 35% tax.
Do one of these sound like you? I think I should have described every possible scenario, at least as far as six entities can cover. Pick the one that sounds closest to your situation, and remember that nothing is forever. When your business reaches a new level, and you’re making tons of money, if it’s worth it to change your structure at that point, you can hire some lawyers and accountants to take care of it. (It’s funny to note that, in theory, a C-corp has a perpetual life… but even those can be dissolved!)