Different types of business entities
Regrettably, many people who start a business do not put a lot of thought into selecting the best business entity for their particular circumstances. Instead, they follow the path of least resistance (“it was so easy to just start as a sole proprietorship”) or yield to their own pre-conceptions (“but all businesses with more than one owner are corporations, no?).
We strongly suggest you devote some time and energy researching the various business entities available in your jurisdiction, to make an informed decision based on your particular preferences.
Examples of business entities
Important: Exactly which business structures and entities that are available and the rules governing them will vary from one jurisdiction to the next. It is therefore very important that you obtain information pertaining to your specific jurisdiction. Below, we will just take a look at a few business entities that are common in the United States. Most other countries offer similar, albeit not identical, entities. Even within the United States, rules do vary between the various states and territories.
The sole proprietorship
If you run your business as a sole proprietorship, you are personally liable for everything. This is a risky way of running a business, but many people still chose it because it is easy to form. When you file your taxes, there is (in most jurisdictions) not really a strict separation between the individual and the business.
A partnership is similar to a sole proprietorship in many ways, but always involves a minimum of two individuals. These individuals (the partners) agree to share in the profits and losses of the business.
In most jurisdictions, the profits and losses are passed through to the partners and they report them on their individual income tax reports.
Just like the sole proprietorship, the partnership is not a good idea if you want to limit your liability. What makes the partnership even riskier is of course that you are liable not just for your own actions but also for the actions of the other partners.
Limited Liability Company (LLC)
If you want to limit your personal liability, but doesn’t want to go all the way and form a corporation, the LLC can be a good compromise.
In most jurisdictions, you can form an LLC alone or with one or more partners, and profits and losses can be passed through to the owner(s).
A corporation is a legal entity that is etirely separate from its founders and owners. Most of the mid-sized and large businesses in the world are corporations, but even a very small business can be a corporation.
In most jurisdictions, it is possible to form a corporation with one owner or several owners.
A corporation provides its owners with a strong shield against personal financial liability (provided that you follow the law, of course).
Profits and losses of a standard corporation are not passed through to the owners – the taxes are filed separately. (In the USA, some states offer the Subchapter Corporation model for those who wish to pass on profits and losses from the corporation.)
Compared to an LLC, a corporation typically requires more extensive record-keeping and filing.