Launching a new business venture can be a time-consuming and nerve-racking experience. Whether you are a solopreneur, have a business partner or are part of a group forming a start-up, you are going to have many choices and decisions to make. One of the first business decisions you will confront, once you have committed to forming a new business venture, is deciding what entity form to select.
Assuming that you are a small business owner or a group of people wanting to form a start-up, what is the best entity to form? Here are your options-
- Sole proprietorship
- General Partnership
- Limited Partnership
- Professional Corporation
- Limited Liability Company
- Series Limited Liability Company
- Limited Liability Partnership
That list, to many people, is surprisingly long. While the number and variety of entities available in Indiana might be surprisingly long, for most small or start-up companies, the choice is quite simple. Before we look at each entity separately, keep in mind that there are several factors to consider in selecting an entity form, such as –
- What product or service will the business provide?
- How many owners will be involved initially and then eventually?
- Are the owners all U.S. citizens or permanent alien residents?
- Are any of the owners a entity themselves?
- What is the projected lifespan of the business?
- How will the business be operated?
- How will the entity be managed?
- Are all of the owners Indiana residents?
- Will the business have employees, besides owner-workers?
The answers to these questions will impact a lawyer’s advice on how to structure a business and whether to use one entity versus another. There is as much art as there is science in selecting, forming and documenting the right entity structure for a business, which is why you should consult with a knowledgeable attorney before forming a new business entity. While this article gives you some basic ideas on how to select the right business structure, you are always well-served by working with an experienced and knowledgeable business attorney, whenever you start a new business.
Here are some basic data on each of the entities listed above-
SOLE PROPRIETORSHIP- This is one-owner business offering a product or service using that person’s name or an assumed business name. For example, Bill Smith operates as “Bill’s TV Repair.” That assumed business name may be registered with the Secretary of State, but, in the end, there is no business entity. It’s just Bill. The owner of the business is completely liable for the debts and bad acts of the business. This is a “tax flow through” business structure, in the sense that all of the profits of the business will be taxable income of the owner.
GENERAL PARTNERSHIP- This structure is two or more persons offering a product or service, usually under an assumed business name. For example, Bill takes on a partner and renames the business “Bill & Mike’s Appliance Repair.” That assumed business name can be registered with the Secretary of State, but, in the end, there is no business entity. The owners of the business are completely liable for the debts and bad acts of the business. Even worse, one partner can make the other partners liable for the debts and liabilities of the business. This is a “tax flow through” business structure, in the sense that all of the profits of the business will be taxable income of the owners in proportion to their ownership interests. General partnerships can be formed by “accident,” in the sense that the law only requires two or more persons to agree to engage in a business effort with the intent to share profits in order to form a general partnership.
LIMITED PARTNERSHIP- A limited partnership is formed by filing documents with the Secretary of State. There are at least two partners, one is the general partner and the other is the limited partner. The general partner, which is usually its own limited liability entity (usually a corporation) manages the business, while the limited partner is said to be “silent.” Thus, limited partners are often referred to as “silent partners.” This is a “tax flow through” business structure, in the sense that all of the profits of the business will be taxable income of the owners in proportion to their ownership interests. Unlike the sole proprietorship and unlike the General Partnership, there is some asset protection provided to the limited partners, as long as they stay truly “silent” on the business’ operations.
C-CORPORATION- A corporation is a business structure, usually involving 100’s, 1,000’s or 10,000’s of owners, called shareholders. This entity provides asset protection for the shareholders as owners, and the officers and directors from most liability risks. Unfortunately, the C-corporation is not a tax flow through entity. Rather, the corporation pays taxes and then, when the shareholders receive a distribution, there is second level of taxes owed. Thus, the corporation is often referred to as a “double tax” entity. The advantages of the C-corporation for shareholders are (1) asset protection as owners and (2) no taxes are due on a shareholder’s share of the net profits unless and until the corporation distributes those profits to the shareholder.
S-CORPORATION- An S-corporation is a small business structure, involving fewer than 100 shareholders. It is a corporation that has filed a form with the IRS to be taxed as a small business in order to avoid the double taxation of a C-corporation. Thus, the S-corporation is a tax flow through entity. The asset protection of an S-corporation is essentially identical to that of any other corporation
PROFESSIONAL CORPORATION- A professional corporation is a special corporation available to certain licensed professionals. It can be taxed as a C-corporation or as an S-corporation.
LIMITED LIABILITY COMPANY- A limited liability company (the LLC) is probably the most flexible entity structure we have today. It can be taxed as a sole proprietorship (if there is just one owner), a partnership (if there are two or owners), an S-corporation or even as a C-corporation. Similarly, the LLC can be organized and managed as a sole proprietorship (if there is just one owner), a partnership (if there are two or owners) or a corporation. The LLC is easy to create and easy to maintain with fewer required corporate formalities than the law requires of the corporation. In the absence of a reason to form a Series Limited Liability Company, the LLC is usually the preferred entity form for small businesses and start-up’s.
SERIES LIMITED LIABILITY COMPANY- A series limited liability company is an LLC with multiple business operations or locations that are intended to be separate. The advantage of the series LLC is that the owners can segregate their business risks, thereby lowering the investment risks of the members of the series LLC. For example, real estate investors can utilize the unique asset protection features of the series LLC by creating multiple series, with each series holding title to a separate parcel of investment real estate. Please read THIS ARTICLE on our website for a more detailed explanation of the series LLC as a tool for real estate investors.
LIMITED LIABILITY PARTNERSHIP– A limited liability partnership (the LLP) is similar to the LLC structure, but the partnership agreements crafted for LLP’s are often long and complex. The LLC is a preferred business structure, because much of the governing rules for the LLC are “baked into” the law and are simpler.
THE LLC AS A PREFERRED ENTITY– It is virtually impossible for a lawyer or CPA to recommend that every client use one entity form to the exclusion of all others. However, in most cases, the attorneys at GRIFFITH XIDIAS LAW GROUP recommend that small business owners or start-up companies use the LLC structure. Then, working with the company’s tax advisor and after carefully considering several factors, we will make a strategic choice whether or not to have the entity taxed as a sole proprietorship, partnership or S-corporation. Only rarely will we have the entity taxed as a C-corporation. Also, for all real estate clients, specifically clients holding title to property for investment purposes (landlords), we normally advise that the LLC should be taxed as a sole proprietorship or partnership. Again, for many real estate clients, the Series LLC might be the best entity choice.
Of course, selecting the right entity structure and determining its tax filing status are just the start of what a knowledgeable real estate attorney will review with the owners of a small business or start-up company. Management structures, buy-sell agreements, contracts, employees, trade secrets, intellectual property rights, and a number of other topics should be discussed as part of the process to protect a business owners assets and lessen business-related risks.