Setting up a business is always a stressful process. To add to such stresses, there are numerous legal entities to choose from. You can be a sole proprietorship, a general partnership, a limited partnership, a limited liability partnership, a limited liability company, or a corporation. How do you decide? What factors should you take into consideration when deciding? There is no right answer to your decision, there are just various factors you should weigh when considering your choices.
Below is a very brief summary of some of the various forms businesses can operate under. In the coming weeks, I will go more in-depth in my analysis of each type of entity.
Sole Proprietorship — This is regarded as one of the simplest forms of conducting a business. You do not create a new legal entity and the taxation structure is simple. If you are an individual looking for something as basic as possible, this may be your choice. Though, it is important to note that if you choose to operate as a sole proprietorship, all of the debts and liabilities of such a business will fall on you personally; you will not be afforded the same type of protections that are available to other types of entities. Additionally, a sole proprietor reports all business income and losses on their personal taxes — this is called “pass-through” taxation.
General Partnership — This is very similar to the sole proprietorship above, but instead of being a single individual, a general partnership has two or more partners and all are equally liable for any of the debts or liabilities of the business, unless otherwise agreed upon in a partnership agreement. As with a sole proprietorship, there is no limit to the liability of the partners and the profits and losses of the business pass through to the owners.
Limited Partnership — A limited partnership is a partnership consisting one or more general partners and one or more limited partners. The general partners manage the business and are liable as they would be in a general partnership. Limited partners do not participate in the management of the business, and their liability is limited to the extent of their investment in the business. Limited partnerships are also pass-through entities.
Limited Liability Partnership — A limited liability partnership (“LLP”) is a hybrid of a general partnership and a limited liability company (“LLC”). It provides, as the name suggests, certain limitations to the liability of the partners, while allowing for a flexible management structure. It is also taxed as a pass-through entity. It should be noted that LLPs are only available to some professions, such as lawyers and accountants.
Limited Liability Company — An LLC is unincorporated entity with members, sometimes managers, and is organized under state law. An LLC has “members” who are the owners of the business. There are two types of LLCs: one is a member-managed, where the members are in charge of managing the entity, or manager-managed, which has one individual acting as the manager and operating the business. Similar to all the other entity types listed above, an LLC is taxed as a pass-through entity, where the income and losses flow through to the members in proportion to their interest in the business.
Corporation — There are numerous types of corporations, which I will go through in a future article. This entity type is a legal entity separate and distinct from its owners. The owners of a corporation are the shareholders, whose liability is limited to their investment. The actual entity is managed by a board of directors. In Oregon, a corporation must also include at least a president and a secretary as officers. A corporation’s tax structure can differ substantially from each of the above, which are pass-through entities.
In selecting an entity, individuals need substantially more information to make a decision, as there is many advantages and disadvantages to each type of entity. The above is intended only to act as a snapshot of the various options. Consulting with an attorney and/or a tax professional who can guide you in making such a decision is important to setting you up for success.