Business Entities – Which One To Choose?

Business entities like businesses come in many shapes and sizes. Depending on what kind of business you have, you may be limited in your choice of entities for that business. A short and to the point definition of an entity for your business, is a business that is created to make money. This business can be owned by a single owner, or a several owners. Depending on where your business is located, you may have to meet some legal requirements for your business entity. Let’s review the different kinds of entities for you to choose from.

Sole Proprietorship

One type of business entity and the most common that you will find is the sole proprietorship. Which is a business that is operated and owned by only one person. The owner is the one that benefits from all profits made by the business, but also resumes all responsibility for it as well. If you are not looking to go into business with anyone else, and just for yourself, this may be the ideal entity for you and your business.

General Partnership

When you have more than owner for your business, the entity you may want to consider is called a general partnership. This type of company is owned by more than one person, which all share in the profits made by the company, as well as all of the responsibility that the company requires.

Corporation

A corporation is a business entity that has a board of directors. The board of directors make the major business decisions and vote on changes for the company. The money that is made from a corporation is split with the shareholders of the company.

Limited Liability Partnership

Another type of entity to consider for your home business is the limited liability partnership. This business is a lot like a corporation with the exception of the board of directors. The owners can either manage the business themselves, or offer that position to someone else.

Limited Partnership

A business entity that is called the limited partnership is owned by general partners which are active in the company, and limited partners which are more or less just investors. This type of company is ran by the general partners, and the limited partners are somewhat limited in the role that they can play in the company.

With all of the many business entities that you can choose from, you are sure to find the best one that suits the business that you want. Be sure to thoroughly research each one of the entities and make sure that you are following all of the laws in the state that you are doing business in.

Learn the Differences Between Each Legal Business Entity Type

Your individual state will register your legal business entity, and it’s important to understand that not all states recognize every business entity type. The descriptions below are meant to give you a basic understanding of the differences between entities, but you should check with your local government to see which type of business designation is right for your new venture.

Sole Proprietorships

Most small businesses choose the legal business entity of a “sole proprietorship”, where one person is the only “owner” of the business. Legally, there is no difference between you and your business, and while this business entity type is preferred by some because of the ease in setting it up and registering it, there is a greater legal risk assumed by the owner of a sole proprietorship. For example, if someone sues your business for infringement or fraud, they will be suing you, and your personal assets will be on the line if the case is taken to court – a disadvantage to this kind of legal business entity. This type of situation is rare to be sure, but from a business standpoint, it has the potential to be a risky move.

An advantage of this entity is the fact that you’re the only owner! You can make your own business decisions without having to consider the opinions of a board of directors, or other stakeholders. You receive 100% of the income from your business, and are free to file your profit on your individual tax return at the end of the year – a huge advantage to choosing this legal business entity type.

Partnerships

As the name implies, a partnership is an entity in which two or more people own a business together. Just like a sole proprietorship, there is no legal difference between the owners / members of a partnership and the business itself. As previously stated, choosing this legal business entity can have potentially negative consequences if someone were to file a suit against you or your business. An entity type of this sort carries an additional risk because of the added element of another person. For example, let’s say your business partner did something illegal and the court has decided to penalize your business assets because of his or her mistake. Although you have done nothing wrong, the whole business may be at risk of going under because of the partnership liability. Again, although this is rare, it is important to consider when choosing this kind of legal business entity. Types of considerations like this can protect your investment in the long run.

Speaking of investment, an advantage to a partnership is the ability to raise more funds with the influence of more people. Instead of having to shoulder all of the capital upon startup yourself, a partnership can help business owners divide the cost of operational expenses. And of course, because you’re sharing costs, you and your partner(s) will have to share profits as well. A benefit of this kind of legal business entity is the financial ease achieved by being able to file your profits under your individual tax return at the end of the year.

When starting a partnership, it is important to draw up a legal agreement detailing how costs and profits will be shared, what to do in the event of a partner wanting to leave the business, how to settle disputes about business strategy, etc.

Corporations

Unlike sole proprietorships and partnerships, where the owners are legally the same as their business, corporations offer business owners a unique legal and tax benefit in the sense that corporations are granted their own legal status. Therefore, this business entity type is considered as a separate legal business entity from you, your partners, and your shareholders. If your business were to be sued, it would not put you or your personal assets at any risk. So wait…who are shareholders? Whereas you’re an owner / operator / member of your sole proprietorship or partnership, you become a shareholder in a corporation, because this type of business operates with stock, or partial ownership distributed amongst several people. As a shareholder, you “own” a part of the business, but you also have to routinely answer to a board of directors who steer the direction of the company.

The downside to the legal business entity of a corporation is that you have less individual freedom to make executive business decisions, and you are not in total ownership of your business. This business entity type is more difficult to begin and dissolve, and often must comply with a series of complex federal and state regulations and taxes. However, the obvious benefit to this type of legal business entity is that you have more individual legal protection with the separation of yourself from your business in the event of a lawsuit.

Limited Liability Company (LLC)

Finally, a Limited Liability Company (LLC) is a sort of combination of all of the above business structures. Like the “corporation” business entity type, an LLC offers a legal distinction between a person and their company, but like a sole proprietorship or partnership, it offers the owner or member (we’re back to being called members now) control over business decisions, tax breaks, and offers no stock option. There is no limit to how many members an LLC may have, and it is also possible to just have one member. The obvious upside to this type of legal business entity is that it provides the best parts of both worlds, corporation and non-corporation, but the downside is that it is more difficult to file than a partnership (but is still less difficult than forming a corporation). To date, the federal government does not recognize an LLC as a classification when you file your federal taxes, so you must file either as a sole proprietorship, partnership, or corporation.

So What do I do Now?

As with any kind of legal decision, deciding which business entity type is right for your business is a big decision that requires a lot of thought. This is just an overview of the primary differences between each major legal business entity, so before making a decision, check with your lawyer or accountant to decide which is best for your financial and business interests. It seems complicated at first, but once you get registered with the state, you’ll be on your way toward owning and operating your own business!

Choose the Right State For Your Business Entity

I have helped thousands of people set up Limited Liability Companies (LLCs) and Corporations in Montana and a few other states. Being a Montana attorney, the majority of the LLCs and Corporations I have helped form have been in Montana. For certain reasons, I have advised clients to form their business entity in another state, sometimes sending business away because it was in the best interest of the client.

Of the LLCs I’ve helped form, many have been for non-Montana residents to use as holding companies for vehicles. This strategy is useful for certain people to minimize tax and registration fees depending on the use of said vehicle. Other LLCs I have helped form have been for various profit enterprises or holding companies for real property, both rentals and private property. The LLC is an extremely versatile business entity and a preferred entity for many uses. However, because I have helped so many people with LLCs, I also get a flood of calls regarding LLCs and their use that is not in the best interest of the person calling. Therefore, I do spend a fair amount of time educating people on the benefits of LLCs, and most important, where to organize the entity related to their goals.

The organization of a Montana LLC is great for the tax and registration savings on a vehicle as long as the person operating the vehicle complies with the State laws of the operator’s State of residence and the use of the vehicle. The organization of a Montana LLC is great for a Montana based for profit business. It is also a great entity to own real property located in the State of Montana.

The problems arise when people from different states want to use a Montana LLC to own real property in different states, or to do business in different states. Yes, the LLC is a great business entity to use for asset protection, tax, and liability purposes, however, it must be organized in the right state to provide the most benefits.

My home state of Montana is a great state for vehicles because of the sales tax laws. Nevada is promoted all the time as the State to form business entities for income tax and asset protection reasons. And there are tons of promoters and services that will help you form these entities without providing you any guidance of the law. Sure they are experts at forming business entities. That means they can file the proper forms for you. But have they advised you on the law? I strongly suggest you speak with an attorney rather than some of these other promoters. Recommending everyone set up a Nevada entity, or a Montana entity, is poor advice at the least, and it may cost you much more in the end than paying an attorney up front.

This is why it is poor advice and may cost you. You might not have any liability protection at all! Yes, that’s right, the entity you set of for liability protection might not provide an ounce of that protection. Each State’s laws are different, so you really need to talk to an attorney in the state you reside in or are doing business in. However, in general you need to know that the asset protection and liability protection provided by a business entity is only provided by the State that the entity is formed in or registered as a foreign entity where the entity is doing business.

This means that if you are operating a for profit business with a Nevada or Montana business entity in a state other than Nevada or Montana and you have not qualified the business entity to do business as a foreign entity with that state’s Secretary of State or governing body, there is most likely no protection. If a business entity is doing business in a state where it was not created and was not qualified as a foreign entity, the owner or owners of the business may be held personally liable for any debt or obligation incurred by the entity.

Therefore, I usually recommend to people that they form business entities in the state where they will do business, and form business entities for owning real property in the state where the real property is located. If you are going to use a business entity formed in a different state, you need to qualify it in the state where you will do business or own real property. (This means paying the correct fees and filing the required documents to both states)

For certain situations, there are advantages to forming business entities in Montana, Nevada, Delaware, etc. However, it really depends on what the goals and objectives for having a business entity are, and where you will be doing business or purchasing assets. If you don’t do things right, you may not have the protection you believe you have. Do yourself a favor and seek out qualified advice before forming your entity, and remember that there is no single solution, single business entity, or single state that is best for everything or everyone. Do a little homework, ask qualified people, and you will be able to maximize the use of your business entity to satisfy your needs and goals.