GUEST BLOG: Choosing a Business Entity – The Pros and Cons
Submitted to Investment Real Estate by Frank H. Countess at CGA Law Firm
When a person starts a business, one of the first issues that must be tackled is choosing what type of business entity to become. Generally, there are four kinds of business entities; A Sole Proprietorship, a Partnership, a Limited Liability Company (LLC), and a Corporation. Each type of entity has its own pros and cons with regards to business operations, money management, taxes, legal liability and the list goes on. However, we will focus on just a few distinctions between the four types of business entities, when deciding which entity is the correct one for the business itself.
The first type of entity is the Sole Proprietorship. Many self storage facilities start out this way. From the moment somebody opens up their own shop or business, they are a sole proprietor. Whether a person is selling handmade jewelry to their friends or running a full automotive repair store out of their garage, they are a sole proprietor. This means the person who started the business is responsible for all of the company’s profits and liabilities. This is attractive if a person wants complete control over the business decision making and wants 100% ownership. There are two major points worth discussing about a sole proprietorship: taxes and legal liability. First, the good news, as a sole proprietor the business owner is only taxed once. This is because the business profits, are the owner’s profits. With other entities, a business is sometimes taxed twice. Therefore, with a sole proprietorship, the taxes are typically much lower, considering the owner is not taxed on both his/her income, as well as the business being taxed.
When a person owns a business as a sole proprietorship, there is no legal distinction between the business and the owner. They are viewed as one “entity” combined. This means that the liability associated with the company and its employees falls directly on the owner. As such, anyone with a legal claim against the business, will likely sue the owner as well. This is the major concern with having a sole proprietorship. Business owners do not want their personal assets to be at risk if a business-related lawsuit arises, and that is why most small business owners choose one of two other options which are called a Partnership, or a Limited Liability Company (LLC). It is important to note that these entities require more than one owner.
The second type of entity is when multiple owners want to form a Partnership. There are various benefits that flow from this type of business. When filing a partnership, a primary advantage is that the partnership does not bear the tax burden of profits or the benefit of losses. Profits or losses are “passed through” to partners to report on their individual income tax returns. A primary disadvantage is the liability each partner has in a partnership. Each partner is personally liable for the financial obligations of the business. Therefore, they are all liable for the debts of the partnership. Whether that be fully liable under a general partnership or liable for their pro-rata share of the company’s liabilities under a limited partnership.
Limited Liability Company (LLC)
The third type of entity is a Limited Liability Company (LLC). An LLC is formed when one or more individuals create a special written agreement collectively to engage in business activities together. The agreement details the organization of the LLC, including provisions for management, assignability of interests and distribution of profits and losses. LLCs are permitted to engage in any lawful, for-profit business or activity other than banking or insurance. A limited liability company allows owners, partners or shareholders to limit their personal liabilities, while still enjoying the same tax benefits as a partnership.
When a business becomes an LLC, the owners are protected from personal liability for the debts of the business, as long as it cannot be proven that they have acted illegally, unethically or in an irresponsible manner in carrying out the activities of the business. When forming an LLC, the owners can choose whether they want to be taxed as a partnership, or as a corporation, which leaves a lot of room for flexibility. The LLC is one of the best forms of business entities and carries a lot of benefits with very few burdens. One of the only disadvantages of forming an LLC is that, generally, it is more expensive to form an LLC rather than a partnership or a sole proprietorship. LLCs are often a good entity to utilize for owning real estate, such as self storage, as well.
The last form of a business entity is a Corporation. Within the category of a corporation, there are various sub-categories of corporations. Generally, a corporation relieves the owners of responsibility for the liabilities and debts of the business. This means that the owners’ personal assets are not able to be seized if the business fails to meet its obligations. Corporations are generally eligible for more tax deductions than other business entities. However, there are certain types of corporations such as the C-corporation that are subject to double taxation. This is where the company pays taxes on the corporate tax return, and the shareholders also pay taxes on the dividends they earn.
When a business is founded as a corporation, the owners have the opportunity to create stock in the company, allowing others to invest in the company and become part owners. This is great for raising extra capital, and to help the company grow if they ever want to become a publicly traded company. One of the only major disadvantages is the strict government regulations. There are government regulations that govern just about everything for corporations, such as creating a board of directors, recording minutes, how to sell stock in the company, and creating bylaws for the corporation. The control of a corporation tends to be more diverse and cannot be held strictly by one or two people. A corporation is not for everyone. However, there are plenty of benefits to being a corporation, and if carefully established, a business can succeed and grow very fast.
There are many different types of business entities to choose from, each with their own pros and cons. The main takeaway is, choose the entity that is right for your business. Every business can succeed if formed correctly and managed well. The type of business entity will not necessarily affect how well your business performs, however, it is pertinent when considering how fast you want to grow. Sometimes staying smaller and local is better, sometimes growing and selling stock is more beneficial. There are lots of options, and all have their own advantages and disadvantages. This is why consulting an attorney and doing research prior to your choice of business entity is essential.
About the author:
Frank Countess concentrates his practice in the areas of real estate law, business law, commercial transactions and estate planning/administration. He is a licensed real estate broker, a licensed title insurance agent and Chair of CGA Law Firm’s Real Estate Group. He also serves as the Solicitor for the York County Recorder of Deeds Office. Frank represents both residential and commercial clients in all types of real estate matters. Contact Frank at [email protected] or 717-848-4900 for more information.