Many important decisions must be made when you start your own business. One of the most crucial choices is selecting the correct entity that reflects your business model and helps you achieve your dream of owning a successful company.
Choosing the right entity at the outset determines your business’s tax and other legal considerations. Different entities offer various benefits, such as separating personal and company assets and protections over liability concerns.
Common types of business entities
Depending upon the product or service you offer, here are some of the most common business entities to choose from and a brief explanation of some of the pros and cons they offer:
Sole proprietors
If you plan to run the business yourself, a sole proprietorship is one of the most straightforward entities to set up, but it also comes with significant risks. These businesses typically involve a single owner who puts the company in their own name, with all financial responsibilities paid out of their personal account. The potential risk comes from the owner being personally responsible for all issues related to the business.
Partnerships
If you want to start a company with a friend or family member or plan to take on a partner or partners, limited and general partnerships are the next step up from sole proprietors. Here are the differences between the two:
- General partnership: As the company’s founder, you bring on a partner to share responsibility for all the business’s obligations.
- Limited partnership: Personal liability for each partner is confined to the amount each invests in the business.
Tax returns for the business are separate from the partners’ personal returns. Partnerships are usually cost-effective, but if one partner can’t meet their financial duties, the other may also be held responsible.
Limited liability companies
LLCs are a hybrid, allowing the tax benefits of a partnership while limiting personal liability. These benefits can outweigh the more considerable tax consequences since LLCs must pay state, local and federal taxes. LLCs may not be a good choice for those hoping to attract venture capitalists.
Corporations
These entities are separated from their owners and have their own legal rights. Corporations can buy and sell property, issue stock to raise capital and file lawsuits. The primary benefit is that shareholders and owners have no financial or legal liability for the company. Types include C corporations, S corporations and nonprofits. They are much more complex than other entities.
Understanding DBAs
While not technically a business entity, California requires you to file a DBA if your company is a sole proprietorship, partnership, LLC or corporation. DBA stands for “doing business as” and allows you to register the business under a name other than your own or another you originally filed with the California Secretary of State.
DBAs offer many benefits, such as separating business and personal bank accounts, keeping your business legally compliant, defining your brand and maintaining your privacy. Finally, many startups wait until later in the process to seek experienced legal guidance. Talking to an attorney early on is crucial for selecting the entity that fits your needs and meeting state, local and federal requirements.