Maybe you are thinking, what is a business entity? Do I have to pick one? The short answer is no, you don’t have to choose a business entity but you are going to be considered an entity by the law anyway, so why not choose for yourself and take advantage of the options?
There are several kinds of business entities, each with specific advantages and caveats. While the process of becoming a business entity can be relatively simple, the choice is crucial. The key things to think about when choosing an entity are liability, taxation, and ownership. For example, a limited liability company (LLC) will typically protect you as an individual from contractual liability and certain tort liabilities incurred by your employees (but not torts committed by you personally even if in the course of business). So, if you take out a loan in the business’ name and the business is unable to repay the loan, you will be protected from personally responsibility to repay the debt (as long as you did not sign a personal guarantee). Or, if an employee accidentally makes a jalepeno churro too hot and you get sued for burning someone’s mouth, it’s likely that only the business will be liable.
Probably the most important aspect of entity choice is taxation. With both an LLC and a Partnership, pass through taxation requires both the owners and/or shareholders to pay taxes on their portion of the profits, just like you would on a pay check from a company you worked for. However, if you form what the IRS deems a C-Corp then you will not be taxed on the profits and the corporation will be treated as if it is it is a person. Finally, entities can control the issues of ownership and authority. Do you want to be in complete control of your business? Do you feel comfortable handing over some decision-making power to a board of directors? Do you want others to have a fiscal stake in the entity? If you choose an LLC you have flexibility to decide if you want to have sole control or if you would like to invite other members or shareholders to have a say in matters. If you form a C Corp, you need shareholders, directors and officers. In limited situations the shareholders can also serve as both directors and officers and retain more control of the company but the general structure is mandatory.
Liability, taxation, and control are all things that add to the risk and decision making burdens in any start-up. Understanding the differences between entity structures and choosing the one that best suits your business can minimize your risk and help you make efficient business decisions .