Choosing the Right Entity for Your New Business
Guest post by Ryen Rasmus, Esq., The Lipp Law Firm, PC
Congratulations! This is an exciting time in your professional life – you’re getting ready to launch a new business. Whether you’ll be continuing the same kind of work that you’ve been performing for many years or setting out on a brand-new venture, starting up your new company is a big step that carries major opportunities, but also more than a few risks. As an attorney, I help my start-up clients to mitigate their risk as much as possible, and one of the simplest and most effective means of doing so is housing your business within the appropriate legal entity.
There are four major entity types from which an entrepreneur may choose: sole proprietorship, partnership, corporation, and limited liability company.
Sole Proprietorship and Partnership
The first two types, sole proprietorship and partnership, require no formal filing to set up, but rather arise automatically by operation of law when people start doing business. A sole proprietorship is the default when a single person starts doing business, while a partnership is the default when two or more people join together to perform work and share profits. Although these entities are easy to form, they come with major downsides. A sole proprietorship and its owner are treated as one and the same in the eyes of the law, meaning that if someone were to sue the sole proprietorship, the owner’s personal assets (i.e. house, car, and bank accounts) would be on the line and available to satisfy judgments against the owner’s business. Not only is the same true for partnerships, the act of one partner is presumed to be the act of another if it is within the ordinary course of business, meaning that you can get in trouble for your business’s partner’s bad judgment. Moreover, all partners are presumed to be equally liable for a partnership’s profits and debts, even if only one partner does all the work or incurs all the liabilities on the partnership’s behalf.
Corporation and LLC
For this reason, most businesses should be housed within either a corporation or LLC. Each entity insulates its owners against personal liability for the company’s debts, which is a major protection. These entities also provide structure for businesses, as they call for officers, and give the owners more control over the apportionment of profits and liabilities, often based on the roles that the owners perform with respect to the business in practice. To apportion these factors appropriately, the owners should come together to draft a governing document for these entities – a “shareholder agreement” for corporations, or an operating agreement for LLC’s. This document can set forth the parties’ respective duties and obligations and provide certainty that the less formal entities (sole proprietorships and partnerships) often lack.
Of all entity types, the LLC is often the most advisable for new businesses. It is most flexible from a tax standpoint, as an LLC may be taxed as a disregarded entity, partnership, S-Corp, C-Corp, or not-for-profit so long as appropriate prerequisites are met. It also requires satisfaction of fewer formalities than a corporation, disclosure of less information, and (in most jurisdictions) less money to set up and maintain. Unless you’ll be seeking outside investment in the short term, and barring the presence of other specialized business factors, an LLC is usually the right choice.
Specialized Entity Types
There are other, more specialized entity types that may be available depending on the nature of your business, such as non-stock corporations (for not-for-profit ventures), professional corporations (for those in certain regulated professions like doctors and lawyers), and limited partnerships (when different owners will be doing markedly different things for a business).
The decision about a choice of entity is usually very fact-specific, so be sure to consult with experienced legal counsel before making a final decision about what is best for your new enterprise. Congratulations again on this new step in your career, and good luck in moving through these early but crucial steps!
Disclaimer: This material is intended for general information purposes only and does not constitute legal advice. For legal issues that arise, the reader should consult legal counsel.
About the Author. Ryen Rasmus is an attorney at The Lipp Law Firm, PC. Ryen has comprehensive experience in the fields of intellectual property, complex business transactions, and business-related litigation. He specializes in the drafting of contracts and operations documents; resolution of business and intellectual property-related disputes; and counseling in the fields of corporate, employment, and software law. Ryen also serves the firm’s clients by providing mergers and acquisitions-related advice and conducting regulatory oversight reviews to ensure that clients’ businesses are compliant and protected to the maximum extent.