If you are starting a new business, one of the first things on your to-do list should be setting up an entity to run the business through. But how can you set up a company if you don’t know your options?
Real quickly we’re going to run through some of the more common entity types that you may have heard of. Ready? Here we go:
- Sole Proprietor.This is you personally running your business. It’s simple, in fact there is no filing to make with the state and the only tax return to file is your own personal one. However, a sole proprietorship provides zero liability protection and doesn’t look very professional.
- Partnership. The original business entity! Two or more people forming a business. In most cases you and your partners make a filing with the state where your business is located. Tax filings are simple but liability protection is minimal and the partnership form has fallen out of favor for most businesses (aside from investment funds).
- Corporation. The origins of the corporation go waaaay back, but modern corporations in the U.S. were brought about by state legislation in the 1890s. Nowadays, you’ll see most venture backed companies set up as corporations, with the main benefit being that owner liability is limited to the amount invested (with some exceptions). The downside to the corporation is that since it is considered a separate legal entity, the IRS taxes it as such, leading to an inefficient tax model. Over the years various types of corporations have popped up – non-profit, S corporation, and most recently, the Benefit corporation.
- Limited Liability Company, or the LLC. The LLC is a relatively new form of business. It is an extremely popular entity type because it combines the tax benefits of Partnerships and the asset protection of Corporations, giving the entrepreneur a tax efficient model the protects them personally from the business’s risks. It isn’t all good though. LLCs are largely creatures of contract which makes them both very flexible, and potentially complicated.
- Professional Corporation or Professional Limited Liability Company. Most states require certain types of “professional” business to organize with a “P” in front of the designation. Doctors, lawyers, engineers, accountants, etc. PCs or PLLCs are irrelevant if you aren’t setting up a “professional” business, and they typically carry additional filing requirements set by the groups that regulate those types of businesses in your state.
After you decide which type of entity you plan to use, the next step is to think about which state law to use, which is the subject of another short video from Fourscore.