The term “entity” in business refers to an organization run by an individual or a group of people. Each business entity operates under one of four different business structures.
The structure dictates several things about the establishment, such as how it operates and how it is taxed. Some business entities enjoy several benefits depending on their structure, such as one-time tax reductions and accessible financing. These merits also come with many challenges, such as limited flexibility and control. Therefore, it is advisable to gain knowledge about the different business entities first, although you can also enlist the help of a business filing specialist to do this for you.
If you want to register the startup yourself, this article should help you, as it discusses three tips for choosing the right entity for your startup. Let’s start with the most essential advice.
Understand your different options
First and foremost, you need to know what your options are and what each option entails.
There are generally five different types of business entities. Each entity is best described by its respective advantages and challenges or lack thereof.
Here is a brief overview of what each entity entails:
- Sole proprietorships: As the name suggests, a sole proprietorship is a business entity run by a single or “single” person.
- Partnerships: Partnerships are managed by at least two people who are the owners of the startup.
- Company: A corporation is a separate entity from the people who run it. It has the same rights as its owners, such as the right to hire employees, take out loans and pay taxes.
- Limited Liability Company: A Limited Liability Company (LLC) is a hybrid entity that incorporates the characteristics of corporations with those of partnerships.
To note: The limited liability company entity is exclusive to the United States.
With that, you now know your available options. The next step would be to assess your startup’s needs if you want to make the right choice.
Assess the needs of your startup
Every startup has specific needs, some of which can be easily met by choosing the right business structure. Therefore, you must consider the needs of the startup when choosing the entity.
Examples of these needs may include the following:
- The need for financing
- The need for control over the business
- The need to protect one’s heritage
- The Need to Avoid Passives
- The need to save on taxes
- The need to save money on operating costs
- The need to offer some ownership to key employees
The right entity will differ based on these needs, among other things. With this in mind, you then need to determine the pros and cons of an entity based on your needs.
Weigh the pros and cons of each entity as needed
Choosing the right entity for your startup may not be feasible now because you haven’t yet understood what each entity offers. That being said, here is an overview of the pros and cons of each entity:
- A single person runs a sole proprietorship, which means that one person will have full control over the startup.
- The sole proprietor would also receive all of the profits generated by the startup.
- You can reduce your taxes owing by including your business losses on the tax return.
- Registering a sole proprietorship is much easier than for other business entities.
- Filing taxes is easy. The sole proprietor simply has to report business income as well as losses on his personal income tax return.
- You can incorporate a sole proprietorship, later turn it into a corporation.
- The sole proprietor will have to assume the burden of all the responsibilities associated with the start-up. These can be bank debts, mortgage debts and wages due.
- A sole proprietorship does not receive the benefits that other entities enjoy, such as tax reductions and accessible financing.
- Hiring top notch employees will be a challenge.
- Partners will share responsibilities or liabilities associated with the startup. This facilitates the start of the business since each partner can contribute to the financing.
- Filing taxes is quite simple as each partner has to pay taxes based on their share of the profits. The partnership itself is not subject to taxes.
- It is much easier to take out loans than when you are running a sole proprietorship.
- As with sole proprietorships, it is possible to change from a partnership to a corporation.
- No one has full control over the startup, as each partner owns a part of it. Consequently, partners may take reckless actions that may endanger the entire partnership.
- Conflicts of interest may arise within the organization.
- You have to deal with a ton of paperwork each time a partner joins or leaves.
- Each partner appropriates a portion of the startup’s revenue, which reduces your share.
- Not a single person is held liable for liabilities such as debts or taxes. The company is considered a legal entity and therefore it is the responsible entity for these responsibilities.
- You can easily retire by selling the shares or units you own to other shareholders.
- Corporations are more likely to get loan approval than individuals (sole proprietors).
- You can easily attract high caliber employees.
- The shareholders can decide to extend the company to the whole country.
- The process of becoming a corporation is rather difficult compared to other entities.
- Certain types of companies can be subject to double taxation where the startup, as well as the shareholders, are taxed, although this is a rather special case.
- Anyone can own the company as long as they buy enough shares of the company. In short, the hierarchy can vary according to their monetary contributions.
- Confidentiality is limited because financial affairs concerning the startup must be made public.
Limited Liability Company
- Owners are free from corporate obligations, such as debt repayment, just like corporations. An exception to this would be tax, as all owners must pay taxes based on their share of LLC profits, similar to how partnerships are taxed.
- LLC members can withhold their tax by refusing to accept their share of the profits in the meantime. This is because in an LLC, income is not earned until it is received.
- All members of the LLC can deduct their personal income tax using business losses.
- Double taxation is unlikely in LLCs, at least compared to corporations.
- There is no limit to the number of shareholders or stockholders the LLC can have.
- An LLC can take out loans more easily than partnerships and sole proprietorships.
- The combined taxes paid by LLC members are generally higher than what corporations pay. This is because LLC members are subject to personal taxes such as self-employment, social security, and health care taxes.
- LLCs generally cost more to set up, but not as much as corporations.
- Investors are less likely to invest in LLCs than in corporations.
Now that you know the pros and cons of each entity, it should be easier to decide which option is best for your needs. For example, if your business requires a lot of funds, choosing the LLC entity or corporation is ideal because they make it easier to take out loans. Likewise, if you have everything you need, it’s best to choose a sole proprietorship so you can reap the benefits for yourself.
By now you should have already decided which entity you choose. It may have been confusing and overwhelming, but at least now you won’t regret making your decision. After all, with the advice mentioned above, you can safely say that you have made a well-considered decision. Now all you have to do is make your startup successful by applying your business skills to the fullest.