CREATING A NEW BUSINESS: WHAT TYPE OF ENTITY SHOULD YOU CHOOSE?
While COVID-19 resulted in nearly unparalleled strain on the economy and many businesses suffered, it was nonetheless a time of prolific new small business formation. The high number of new formations of small businesses seems to be persisting. This would seem, then, a prudent time to revisit the topic of choice of entity when establishing a new business. In this article, we’ll review the five most commonly chosen business entities for new FILERS
Corporations: A corporation is a fictitious legal entity, with its own tax ID number and A complex set of applicable regulations governing its operation. Ownership interests in a corporation are determined by the number of shares each shareholder owns. They are often controlled by a Board of directors, and a set of corporate officers such as the President, CEO, Vice President and/or Treasurer. Often, small businesses operating as corporations are single shareholder entities, with a single person filing all of the ownership and management roles within the company.
A Corporation can take two general forms for tax purposes – a C Corp. or an S Corp. An S Corp. allow for “flow through” tax treatment, which many small business owners find desirable.
Limited Liability Companies: Often referred to as an LLC, ownership interested in an Limited Liability Company are determined by the content of an Operating Agreement. While there are not multiple forms of LLC’s, an LLC owner can elect to be treated either as a corporation or and LLC (with flow through tax treatment) for purposes of taxation. LLC’s are desirable for many reasons other than their flexibility in ownership and tax status. Persons starting a small business with substantial assets, who are concerned about a personal liability, might choose an LLC for its asset protection properties as well.
Limited Partnerships: These arrangements were, long ago, often referred to as “woolen merchant” arrangements. Limited Partnerships are created through registration with the Department of State, as are LLC’s and Corporations. However, there are two tiers of membership. General Partners, who assume the full control over, and liabilities of, partnership in a general sense, control the day-to-day operations of the business. The second tier of partner – the limited partner – has no operational control over the business. Because of this, the limited partner enjoys limited liability. In exchange, the limited partner functions mostly as an investor. These limited partners were often considered “woolen merchants” because they had no control over, or knowledge of, the operation of the business, and therefore had “wool” pulled over their eyes as to operations while benefiting from the profits of the business.
Sole Proprietorship: This is the default status of any new business that does not otherwise engage in entity formation. If you are not a Corporation, LLC, Limited Partnerhsip, or General Partnership, and you are conducting business, you are a sole proprietor. Sole proprietors remain fully liable for all of the debts of the business, there is no corporate shield protection, and directly benefit from the profits of the company’s operations.
General Partnership: Any two or more persons who own a business together, who do not otherwise form a corporate entity such as an LLC or Corporation, are, by default, a general partnership. The relationship between the partners is often, and always should be, governed by a document called partnership agreement. The major distinguishing characteristic between a sole proprietorship and a general partnership is simply the number of owners.
Benefit Corporations: Benefit Corporations are formed, in addition to the purpose of conducting a business for profit, for the purpose of creating a “general public benefit.” A “general public benefit” is a “material positive impact on society and the environment, taken as a whole, assessed against a third-party standard, from the business and operations of a benefit corporation.” This is often truncated to the term “positive externalities” that might not have, as their immediate goal, the maximization of profit. While profit is generally a consideration, for Benefit Corporations, “The purpose to create general public benefit shall be a limitation on the other purposes of the benefit corporation, and shall control over any inconsistent purpose of the benefit corporation”, including profit as a purpose.
If you are a small business owner, or are considering opening a new business, it is important to discuss the benefits of each of these entity choices with an experienced business attorney. The choice of which entity to utilize can be influenced by the assets of the business, the wealth of the owner(s), the nature of the debts and liabilities each particular business faces, the estate planning goals of the owner(s), and whether the area of business is in some area of high risk. If you have questions about which type of business entity to choose, or would like to discuss whether you should change organization status, reach out to our offices today to speak to our experienced attorneys.
Helpful links when researching what type of entity formation is right for your business may include the following:
NYS Dept. of State FAQ for corporations and business entities.