Types of Business Entities

Sole Proprietorship

This is a business run by one individual for their own benefit. It is the simplest form of business organization. Proprietorships have no existence apart from the owners. The liabilities associated with the business are the personal liabilities of the owner, and the business terminates upon the proprietor’s death. The proprietor undertakes the risks of the business to the extent of their assets, whether used in the business or personally owned.

Single proprietors include professional people, service providers, and retailers who are “in business for themselves.” Although a sole proprietorship is not a separate legal entity from its owner, it is a separate entity for accounting purposes. Financial activities of the business (e.g., receipt of fees) are maintained separately from the person’s personal financial activities (e.g., house payment).

Partnerships–General and Limited

A general partnership is an agreement, expressed or implied, between two or more persons who join together to carry on a business venture for profit. Each partner contributes money, property, labor, or skill; each shares in the profits and losses of the business; and each has unlimited personal liability for the debts of the business.

Limited partnerships limit the personal liability of individual partners for the debts of the business according to the amount they have invested. Partners must file a certificate of limited partnership with state authorities.

Limited Liability Company (LLC)

An LLC is a hybrid between a partnership and a corporation. Members of an LLC have operational flexibility and income benefits similar to a partnership but also have limited liability exposure. While this seems very similar to a limited partnership, there are significant legal and statutory differences. Consultation with an attorney to determine the best entity is recommended.

Corporation

A corporation is a legal entity, operating under state law, whose scope of activity and name are restricted by its charter. Articles of incorporation must be filed with the state to establish a corporation. Stockholders’ are protected from liability and those stockholders who are also employees may be able to take advantage of some tax-free benefits, such as health insurance. There is double taxation with a C corporation, first through taxes on profits and second on taxes on stockholder dividends (as capital gains).

Small Business Corporation (S-Corporation)

Subchapter S-corporations are special closed corporations (limits exist on the number of members) created to provide small corporations with a tax advantage, if IRS Code requirements are met. Corporate taxes are waived and reported by the owners on their individual federal income tax returns, avoiding the “double taxation” of regular corporations.

Advantages/Disadvantages

Sole Proprietorship

• Simplicity of organization-this is the most common form of business organization in the United States because it is the easiest and least expensive to establish.
• Minimum legal restriction-fewer reports have to be filed with government agencies. There are no charter restrictions on operations.
• Ease of discontinuance-the business can be terminated at the will of the owner.
• The owner is truly the boss, making all decisions, keeping all profits, and assuming responsibility for all losses and debts.
• Difficulty in raising capital-this can be a problem since an individual’s resources are typically less than the pooled resources of partners.
• Limited life of the business-untimely, unanticipated, or unplanned removal of the proprietor from the operation of the business may have ramifications for creditors.
• Unlimited liability-this is by far the greatest disadvantage to the proprietorship. Even though proprietors may invest only part of their capital in the business, they remain personally liable to the full extent of their assets for the liabilities of the business.

Partnership

• Greater possible capital availability
• Greater resources for decision making, support, creative activity
• Unlimited liability in general partnerships
• Divided authority-having to divide the authority for making decisions among the partners can delay the decision-making process and occasionally lead to disagreement.

Limited Liability Company

• Allow greatest flexibility for customizing the structure of the business
• Limits member liability
• In many states, an LLC may have only one member (have the benefits of a sole proprietorhop but limits liability).
• Requires comprehensive operating agreement because of the high degree of variability/flexibility

Corporation/S-Corporation

• Limited liability to stockholders-liability is limited up to the amount invested personally in the business. In addition, personal assets may not be seized by creditors to satisfy debts (although now creditors often request personal guarantees on business loans).
• Perpetual life-the business continues as a legal entity. Shares in the corporation can be passed on to heirs.
• Ease of transferring ownership-stockholders can sell their shares when they desire, if there is a market.
• Ease of expansion of the company-greater capacity to raise capital by legal sale of stock.
• Government regulation-a corporate charter must be obtained from the state, and the corporation is subject to all state and record keeping regulations that pertain to corporations.
• Costs to organize a corporation are higher.
• Unless permission is obtained from other states, the corporate charter restricts operation to the state where it was issued.
• Double taxation feature unless S-Corporation election is made.