The legal structure you select for your business is critical. It will impact your tax responsibilities, your ability to raise outside funding, and your liability exposure. In this article, we will briefly review five primary legal entity types.
The Sole Proprietorship
As a sole proprietor, you and your business are considered one and the same from both a legal and a tax perspective. You will report your income on your personal tax return and sidestep the administrative burdens and responsibilities facing other types of businesses.
A sole proprietorship is simple to run and manage, and your profits pass through your business to you, personally. However, there are also several disadvantages. Not only does a sole proprietorship lack the polish and prestige of an incorporated entity, but it does not provide a personal liability shield. Additionally, you cannot seek outside funding or take your enterprise public when you are operating as yourself.
The Limited Liability Company
The LLC is an entity separate and apart from the owner himself, so it provides a personal liability shield. Because you and your business are legally distinct “persons,” you will typically not face personal liability for your business’ debts.
LLCs are simple to structure and run. The paperwork involved is minimal, and they offer several tax benefits. Most notably, the LLC is a “flow-through” or “pass-through” entity, so you are not double-taxed on revenue your business earns.
Nonetheless, LLCs present clear disadvantages for many types of businesses, for instance, those that seek to obtain outside financing or enter an IPO. Most angel investors or VC funds typically won’t invest in an LLC. Additionally, very few public companies are LLCs.
The General Partnership
The general partnership is the default for most businesses with multiple owners. While this structure allows owners to divide ownership as they see fit, they provide no separation between business and personal liability. Also, as with LLCs, most angels and VC funds will not invest in them.
The C Corporation
A corporation is considered its own separate legal “person” with rights and responsibilities. Because of this, it offers its individual owners and officers protection from personal liability.
To form a corporation, founders file paperwork with the state, execute bylaws that govern its operation, and observe corporate formalities. Unlike LLCs, corporations are double-taxed, meaning that revenue is taxed both when the company earns and it when distributions are made to shareholders.
Organizing as a corporation is a prime choice for companies that seek to scale quickly and obtain outside funding. This designation also commands a level of polish and prestige.
The S Corporation
Contrary to conventional wisdom, the S corporation is a tax designation, not a separate legal entity. Like the LLC, its profits pass through to owners, but it also offers protection from personal liability. However, only some companies are eligible for this designation, and the law strictly regulates the issuance of shares, so it is not an ideal selection for every business.
Whether you’re a seasoned business owner or new to entrepreneurship, it is important to engage an experienced attorney to help you navigate the process and ensure that your business is poised for success.
If you are starting a business in North Carolina and have questions about which legal business entity is right for you, call our office today to speak with an experienced business law attorney.