By James Forrest
As a business attorney who regularly works with blossoming entrepreneurs, I often meet with folks who are unsure as to whether they need to create a formal legal entity, and if so, what type of entity best fits their needs. Indeed, with so many options to choose from, selecting an entity can be one of the more daunting tasks for a new business owner.
As with most aspects of business that I talk about on this blog, this is another situation in which sophisticated legal counsel can be quite beneficial. Effective counsel will certainly highlight the benefits of forming any type of legal entity, and the various advantages and disadvantages of the numerous business structures available — so that the entrepreneur may select the entity that corresponds most closely to his or her needs.
One of the most important factors to consider in choosing whether to form a business entity is your personal liability. Most types of legal entities offer a form of “limited liability” for shareholders/members (i.e., an individual seeking a contract claim against your business will have trouble holding you personally liable as a shareholder/member – thus protecting your personal assets). This stands in contrast to a sole-proprietorship or general partnership, which leaves open the possibility that your personal assets could be at risk if something with your business goes wrong.
Another consideration is the economic impact that the various structures may have on your business. In addition to liability protection, the LLC provides economic advantages for business startups that corporations do not. For tax purposes, the LLC allows business losses, profits, and expenses to flow through the entity directly to the members. Thus, unlike in the corporate structure—where taxes are paid at both the corporate and individual level—profits are only taxed once in a LLC. An exception to this is the S-corporation (which we may focus on in a later blog post).
Due to the combination of pass-through taxation and limited liability, the LLC is often a wise choice for a new business out of the gate; however, there are no hard and fast rules when it comes to entity choice. In some instances choosing an S or C corporation may be more appropriate. Each situation is unique, and it is important to consult an attorney who specializes in business law — as well as a trusted accountant, prior to making such an important decision concerning your business. We have a number of accounting firms we work with in tandem on matters like these.