A business entity is basically a set of methods and policy designed which is covered by the corporate law to run any business. These entities govern the business with set of various rules and also have specific objectives in their workings. There are many types of business entities which are chosen based on their needs.
For example, if there is a single person who want to sell certain goods in a shop with limited stock then that person generally chooses a sole proprietorship business entity as it fits his needs and requirements. But if there is a business with million dollar investment and it has multiple investors who also want to control the workings then the most ideal business entity for them are Business Corporation, partnership firms, or Limited Liability Company.
Before proceeding to start your business this question always comes in mind as it plays an important role in building your business. Taxation policy and growth of your business depends upon the business entity you have chosen. Before you choose one it would be advisable for you to read this article and to be damn sure, consult a legal advisor to solve your queries.
Types of Business Entities Commonly Used in the USA:
In general company law, there are various kinds of legal entities but every country has its own policy and thus company law in such countries have their form of legal entities that are made to suit the business of those particular country. Here are few common legal entities generally used in the United States of America.
- Sole Proprietorship
- Limited Liability Company
- Business Corporation
Each of these four have distinct features and are used by businesses based on their type and interest. To know further here is a detailed outlook of each of the following forms of business entities.
A sole proprietorship business is one of the simplest form of business where a single person is the owner of the business and everything is executed on his behalf. He is the sole controller of the business and any type of profit, loss or liability is solely suffered by him. A sole proprietorship business is mostly taken up by small businesses rather than large businesses.
Some of the features of this form of business entity are:
- It is inexpensive to start a sole proprietorship business
- It generally do not have much tax aspects
- Managing accounts and business is relatively simple and easy
- It is feasible to dissolve such business in quick time
- Execution of business, decision making and implementation is quick since only one person is responsible in decision making
- Firm’s liability is treated as that of the owner and he cannot avoid it
- Whole profit share legally belongs to the owner of the sole proprietorship
- On the death of the owner, the business ceases to exist
Taxation is basically subject to the owner rather than the firm since only one person manages the firm. Which means that earning of the firm would not be taxed but it will be taxed as the earning of the individual. Similarly, liabilities will follow the individual rather than the firm and he must have to pay from his personal assets is required.
A partnership is basically a collaboration of two or more persons to form a legal entity known as partnership firm that manages business. A person according to the business law can be an individual, corporation, business firm, trust or any such organisation.
Each of the partners will be responsible for any kind of profit or loss arising of the said partnership firm. A person intending to enter the partnership firm must make an agreement duly promising to share profit and loss of the business along with his shares in the business. They are also required to share the same with government detailing their list of shares, profit and loss arising out of the business.
The basic principle of business law of partnership asks that in case one of the partner fails to furnish any liability then any of the other partner can partially or completely be held liable to pay the liability.
Features of a Partnership Business Entity:
- Each of the partners are liable for loss or liability
- Based on the pact made, each of the partner has to contribute and share the profit
- It is inexpensive to form a partnership firm
- Taxation policy is bit complex but the partnership on a whole is excluded from any kind of taxation
Partnership firms are free to make rules to suit their interest. A partnership firm ceases to exist if certain criteria are met form example, death of any partner, bankruptcy of any partner or as mentioned in the deed. There is basically three types of partnership entities. They are:
General Partnership: In this, general rules of partnership is followed where the partners share equal profit and loss along with liability. Each of the partners have equal say in the firm otherwise specified.
Limited Liability Partnership: In this, one or more general partners manage the business and are responsible for decision making, loss or liability while the rest of partners are only responsible for Investing their share and gain profit from it. They are in no way liable for any liability of loss.
Joint Venture: Joint Venture firms are time based firms where two organizations collaborate to work on special project for a particular time period and after its completion the venture is dissolved.
Limited Liability Company:
A Limited Liability Company or LLC is a new form of business entity that has seen wide acceptance in the business society because of its extremely flexible nature. This form of legal entity has now been accepted by all states of the USA.
In this, there is a partnership, there is share of profit and also there is liability but in a limited form. It is basically a hybrid of Business Corporation and limited liability partnership.
LLC is very flexible when it comes to taxation and managing businesses of various kinds. It is simple as well as complex depending upon how the owners try to design it. The basic aim of LLC is to minimise liability and to expand profit making it an attractive destination for investors.
LLC protects you from personal liability that arises in case of bankruptcy or lawsuit. Your home, personal assets, vehicles and other such assets won’t be at risk. But there are also some risks involved here like you will be held liable if there is a lawsuit filed against you. Also, LLC formation is an expensive business in comparison to sole proprietorship. To add more, you will have to pay self-employment tax on your earnings and shares.
A LLC does not have the full qualities of a corporation. You need four qualities to qualify as a corporation while a LLC adopts only two like limited liability and centralization of management.
A business corporation in its strictest sense is a legal entity formed to conduct business of specific type which is owned by individuals. A corporation is in its broadest sense is a legal entity and is subjected to an individual on its own.
This means that any profit, loss or liability arising of the corporation would be owned by the corporation and the shareholders of the corporation will draw profits from it based on their ownership in the corporation. The basic aim of a corporation is execution of business in order to gain profit.
A business corporation can be both international and domestic in nature. This means that a corporation can be incorporated in USA as well as in any country and will be governed by the laws of that country.
A business corporation is much more a complex form of business in comparison to the rest as it creates a separate legal entity which has lots of formalities. You will have to appoint a CEO, a director and manager that will represent the needs of the shareholders who are basically the owners of the corporation. These shareholders are of two types. There are ones who have a say in the workings of the corporation while the others only invest and get profits in return.
- It casts limited liability on the shareholders
- In case of bankruptcy, shareholders aren’t personally liable
- Taxation policy is complex and the corporation is taxed as well
- Taking decisions are not that easy as it requires majority approval in the board of directors meeting
- It requires particular process to get dissolved
Choosing the Right Legal Entity for your Business
After going through these four common business entities you would have got a rough idea about your choice. Now we will help you in getting crystal clear on your choice.
Why Choose Sole Proprietorship Business?
Here are some reasons why you can choose this form of business entity.
- You will have complete control over your business
- Decisions related to your business will have your complete approval
- All profits arising out of it will be your completely
- You will be taxed once personally
- It is quite simple to manage with limited expense
Disadvantage of Sole Proprietorship Business:
- There would be no difference between you and your business as per law both are same
- Any liability arising out of your business will have to be owned completely by you
- Your business will have limited growth
- Once you die, your business will cease to exist
- In case you go bankrupt, all the properties of yours will be attached to meet the debt you have taken from bank
Why Choose a Partnership Firm?
Here are some of the reasons why you must choose it.
- It is quite easy to raise a partnership firm
- When two or more people collaborate, skills and finances of others enhances growth of business
- With shared interest and profit, one can go a long way together
- Introducing limited liability ensures you don’t suffer much loss in case of liability
Disadvantages of Partnership Firm:
- Partners want to own profits but not responsibility and liability
- One flawed decision of one of the partners will have repercussion on all the members
- When you are only the investor with no right to make decisions, one wrong decision of other can give you financial losses
- While acting as general partner, you own liability which can get personal making huge liability on you
- Partnerships often lead to rifts among each other making it difficult to reach on final decision
Why choose an LLC?
Here are some reasons why you must choose LLC.
- They are extremely flexible and can be used for various types of business ventures
- They reduce liability and increase profits making it advantageous for investors
- Members can have limited liability in the LLC while they can derive benefits from it
- One can have directors or managers if they want but they are not bound to do so
- LLC gives some benefits in taxation as well
Disadvantages of an LLC Business Entity:
- They are costly while incorporating
- They are also very complex in nature depending the way the stakeholders want to make it
- Taxation is not that simple and it requires help from consultants while unemployment tax may also need to be paid which is not in case of sole proprietor
- A LLC cannot cash in checks made on its name
Why Choose a Corporation?
Here are some reasons why you must choose a corporation.
- A corporation is a separate legal entity which is equivalent to a legal person
- You don’t have much responsibility in it
- You won’t be personally held liable in case of loss
- During bankruptcy, only assets of the corporation are seized
- It gives you scope for maximum growth
- Capital is easy available with number of shareholders willing to invest
Disadvantages of Corporation Business Entity:
- Decision making is not that easy. You need a consensus of the majority of members of the board of directors
- It is quite costly to manage a corporation which requires much more complexity
- There is lots of formalities in a corporation
- Profit is not personal to you and you only get a share of the income the corporation makes based on the share you own.
With this, we hope that it is clear to you which type of legal entity will work well for you in USA. Before you choose any, do good research and consult experts.