Learn more about what an entity type is in business.
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In preparing to start your new business, you may have learned that some rules are different depending on your entity type. But what does “entity type” mean?
The definition of an entity type is the legal structure of your business. An individual creates a legal entity to conduct business and engage in trades or related ventures.
There are various types of entities, but the most common ones include:
Each legal entity has specific benefits that may make it more attractive than another legal entity for you as an aspiring business owner.
The type of legal entity that you decide to form will shape the way that your company runs business for the foreseeable future. If you’re an aspiring business owner or multi-business owner, there needs to be consideration put into your business’s entity type. Advantages and disadvantages to some of the most popular entity types are as follows.
A sole proprietorship is one of the most common types of business. Unlike other types of legal entities, a sole proprietorship generally doesn’t require that the business register with the state. However, you may want to file a fictitious business name — otherwise known as a doing business as (DBA) — with the state. Filing a DBA will put your business on record with the state even if there are no other state filing requirements.
Starting a sole proprietorship means that you have the benefit of being the sole owner of your business. Naturally, you will set the tone of the business without having to regard another individual in your decision-making process. However, this form of business subjects you to personal liability in the event of a lawsuit.
A limited liability company is a legal entity that must register with the state. Formation occurs simply by filing a legal document commonly referred to as Articles of Organization. LLC’s are often more attractive to business owners when searching for a legal entity type with the most benefits.
The main benefit to an LLC is that it reduces the amount of personal liability that owners, called members, of the company may face. The members of the LLC aren’t required to pay for any judgments with their personal funds in the event of a lawsuit against the company. Another huge advantage is the benefit of pass-through taxation that LLC members enjoy. Pass-through taxation allows profits from the business to flow directly to the owner’s personal taxes without first being taxed at the business level.
Partnerships, like sole proprietorships, often don’t have to register with the state. However, most partners will at least have a contractual relationship. The benefit of a partnership typically depends on that contractual relationship because many partnerships don’t split profits equally. Instead, each partner’s share depends on the amount each partner is able to invest in the business. One of the main benefits to a partnership is that all partners share in profits and losses. If there is a reason that the partnership owes a debt, each partner will split the losses depending on the terms of their contract (or state law if there isn’t a contract). Although partnerships do also enjoy the benefit of pass-through taxation, they come with the burden of exposure to personal liability like a sole proprietorship.
A corporation is an entity type that is formed by filing Articles of Incorporation with the state. Corporations are owned by shareholders and often controlled by a board of directors. Small business owners are often reluctant to begin a corporation because of the belief that they will lose their ability to control the business that they started. Small business owners should find some relief in the fact that your corporation doesn’t have to be publicly traded. It’s not uncommon to find privately held corporations. Corporation owners also enjoy limited personal liability. A debtor can’t reach any of your personal assets, in most cases, if the corporation is sued.
The business definition of an entity type is the legal structure of your business. Your business entity determines how you conduct business from formation to dissolution. If you’re struggling to decide which legal entity type is suitable for your business consider weighing the pros and cons of each structure.
We offer expert support with our Business Formation Services. We’re here to help as you navigate through the process of business formation. Once you’ve considered the pros and cons of your entity type’s disadvantages and benefits, you can count on us to provide you with the assistance you need to form your LLC or corporation.
Disclaimer – The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.