Selecting the best business entity for you
You can do business in many forms such as a sole proprietorship, partnership, corporation, or limited liability company. To decide which form is best for your business, you must consider different factors:
- What is your overall goal?
- What is your exit strategy?
- How many owners will the business have?
- How much risk are you willing to assume?
- How do you want the entity and owners to be taxed?
Here’s a brief description of the various ways you can operate your business:
A “C” corporation is a general corporation. It is formed by filing articles of incorporation with the state. A corporation typically has bylaws, which govern the operation of the corporation, including election of officers and the board of directors, and the issuance of stock. A corporation protects the stockholders from liability if there is no commingling of funds. The corporation is taxed as a stand-alone entity and distributions from the corporation to stockholders are taxed separately. Most states impose requirements on corporations to have annual meetings, keep certain books and records, and file an annual report. A corporation should also have a shareholders agreement to address such topics as restrictions on the sale of stock, control and management of the company, and dispute resolution mechanisms for shareholders. Shareholders may be employees of the corporation.
An “S” corporation is typically a “C” corporation which elects to be taxed as a “pass-through” entity to the owners’ individual tax returns. There are restrictions on the number of shareholders and who (or what) may be a shareholder. In an “S” corporation, profits must be allocated to shareholders in proportion to each shareholder’s ownership interest in the business.
Limited Liability Company (LLC)
A limited liability company (LLC) combines some of the aspects of a “C” corporation with the pass-through of all profits and thus taxation to the owners. An LLC is formed by filing articles of organization with the state. Liability for owners is limited as long as the LLC is treated as a separate entity. While not required, most LLCs have operating agreements, which govern the relationship among the LLC’s members, including the ability to transfer ownership, decision making among the members, management of the LLC, and allocation of profits and distributions. Profits need not be allocated in proportion to ownership interests. Many of the formalities required of a corporation, such as annual meetings, are not required of an LLC, providing for more flexibility in management. Members of the LLC may not be employees of the LLC.
A sole proprietorship, as the name implies, is a single individual running and managing a business. Profits and losses flow directly to the proprietor. A sole proprietorship may have employees, but the proprietor may not be an employee. A sole proprietor has no limit on potential liability, so this type of business entity exposes the owner to significant risk.
A general partnership has at least two partners. Similar to a sole proprietorship, there is no limit on the potential liability of a general partner. If you have limited partnership, the liability for the limited partners may be limited, although the general partner in a limited partnership still has unlimited liability. A partnership is governed by a partnership agreement, which spells out how the partnership is governed, specifies how profits and losses are allocated and distributed, and may restrict the ability of a partner to transfer ownership. A partner may not be an employee of the partnership, but the partnership may have other employees.
We can help you make the best decision for your specific needs and goals. We will prepare an operating agreement or bylaws and shareholders’ agreement. Let us know how we can help you with this decision.