Starting your own business can be an equally scary and exciting time. It is a time for making big decisions that can have a resonating impact on the success of your organization and even the course of your life. Arming yourself with all the information you can get will help to ensure you make the correct decisions that will set your business up for success.
Lucky for you, we’re basically the accounting equivalent of Superman minus the pecs and the ability to fly. However, just like Superman, we’re here to save the day! Assuming your day would have otherwise been ruined without an explainer for what entity types are and how they impact your business, here’s an explanation below.
So, What is an Entity Type?
A business entity type is the legal structure of your organization. The entity type you choose to use for your business when you found it will determine the amount of taxes paid for the organization as well as your own personal legal liability should your company come under fire from litigation. The entity type of your business also impacts your share of the profits and the growth potential for the organization. Choosing the right entity type for your business will set you up for success while minimizing potential risk for you and any other founders or executives.
United States’ state governments recognize many different legal entity types, but most small businesses incorporate under one of five entity types: sole proprietorship, partnership, C corporation, S corporation, or limited liability company (LLC).
What is a Sole Proprietorship?
Sole proprietorships are the simplest form of a business entity in which the business has a single owner (you). As the sole owner and operator of the business, you personally take on all financial responsibility and legal liability. Forming a sole proprietorship happens automatically when you begin selling goods or services, requiring no formal paperwork or registration. Profits and losses for the company are reported in your personal tax documents at the end of the year.
What is a Partnership?
General Partnerships (GP) are similar to proprietorships in that they are started automatically upon the initiation of business operations, typically not requiring formal registration with your state government. With a partnership, all founders are personally liable for legal action taken against the partnership and profits are reported on personal tax forms.
Limited Partnerships (LP) are different in that some founders have personal liability while limited partners have little to no liability. This makes it easier for business founders to bring on investors without giving over control of their business. Unlike with GP entity types, forming an LP does require formal registration and filing with your state government.
What is a C Corporation?
C corporations are independent legal entities from the founder(s). This means the business itself is liable for legal action while the founders and owners are legally personally separate from the organization. Filing as a C corporation requires adherence to more governance regulations, such as holding board meetings and creating company bylaws. Taxation occurs twice for C corporation owners as the business is taxed as well as personal earnings from company dividends.
What is an S Corporation?
S corporations take advantage of the reduction in personal liability afforded to C corporation owners while not suffering from the double taxation put upon C corporations. S corporations can only have 100 shareholders, which reduces your ability to grow in size when compared to C corporations.
What is a Limited Liability Company?
LLCs provide owners with the flexibility of choosing how the business is taxed. LLCs are separate legal entities from the owner, and the profits flow through to the owners who recognize that income on their personal tax returns. Regulations concerning bylaws and board meetings don’t apply to LLCs; this flexibility makes LLCs rather appealing to most small business owners.
Picking the Entity Type that Fits You Best
Choosing the right entity type for your business will set you up for success by giving you the right amount of room to grow while mitigating personal risk. If you need help with the financial side of your small business, Ignite Spot is the perfect partner for you. We can provide you with guidance throughout each phase of the life of your business from founding day to your millionth sale. Contact us today to learn more about the services we provide.