Entity type refers to the legal structure or form a company takes, such as a sole proprietorship, partnership, corporation, or LLC, which determines its rights, liabilities, and taxation.
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There are various types of business entities in the U.S. today, 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 entrepreneur.
The type of legal entity you decide to form will shape the way your company operates for the foreseeable future. Whether you’re an aspiring first-time business owner or a serial entrepreneur, there needs to be consideration put into your business entity type. Each option comes with its own set of advantages and disadvantages.
A sole proprietorship is one of the most common types of business in the U.S. Unlike LLCs and corporations, a sole proprietorship doesn’t need to register with the state. However, you may want to file a fictitious business name — otherwise known as a doing business as (DBA). 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’ll set the tone of the business without having to involve anyone else in your decision-making process. However, this form of business subjects you to personal liability in the event of a lawsuit.
General partnerships, like sole proprietorships, 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 usually depends on the amount they’re able to invest in the business.
One of the main benefits (and potential downfalls) of a partnership is that all partners share in profits and losses. If there’s a reason that the partnership owes a debt, each partner will split the losses depending on the terms of their contract (or according to default rules 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 sole proprietorships.
A limited liability company is a legal entity that must register with the state. Formation occurs by filing a legal document commonly referred to as the Articles of Organization (some states have different names, like the Certificate of Formation). LLCs are often more attractive to business owners when searching for a legal entity type with a well-balanced collection of advantages.
The main benefit to an LLC is that it reduces the amount of personal liability that owners, called “LLC members,” of the company may face (see LLC members definition). The members of the LLC aren’t required to pay for its debts with their personal assets in the event of a lawsuit against the company.
Another 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 owners’ personal taxes without first being taxed at the business level. This is similar to the tax structure used by sole proprietorships and general partnerships, and it’s a distinct advantage over corporations.
A corporation is an entity type that’s formed by filing a document called the Articles of Incorporation with the state. Corporations are owned by shareholders and controlled by a board of directors. It’s a more rigid structure than the LLC.
Corporation owners also enjoy limited personal liability, like LLC members. A debtor can’t reach any of your personal assets, in most cases, if the corporation is sued. That said, corporations are often subject to what’s known as “double taxation” in which profits are taxed first on the corporate level and again when shareholders file their personal taxes.
The corporation’s biggest advantage over an LLC is the ability to issue stock. Most investors strongly prefer buying stock in a corporation over buying an ownership share in an LLC, and you’ll only rarely see venture capital firms invest in LLCs.
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We offer expert support with our ZenBusiness formation plans. We’re here to help as you navigate through the process of business formation. Once you’ve chosen an entity type, 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 information 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.
Written by Team ZenBusiness
ZenBusiness has helped people start, run, and grow over 700,000 dream companies. The editorial team at ZenBusiness has over 20 years of collective small business publishing experience and is composed of business formation experts who are dedicated to empowering and educating entrepreneurs about owning a company.
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