The Basics of Business Entities: What You Need to Know

This blog will take you through what a business entity is and its characteristics. The importance of choosing the right kind of business entity is also discussed. 

Key Takeaways

  • This is an organization created to conduct business activities.
  • There are 5 main types, sole proprietorships, partnerships, corporations, limited liability companies and limited liability partnerships.
  • How a business is taxed and how liabilities are registered will depend on what type of business entity the business is registered as. 

A business entity is an organization created by one or multiple persons to conduct business activities. There are 5 types of business entities. They are, 

  • Sole Proprietorships
  • Partnerships
  • Corporations
  • Limited liability companies (LLCs)
  • Limited liability partnerships

The type of business entity a specific business is registered as shapes how taxes are paid, and liabilities are determined. Since they’re formed at a business level, they must obey state laws and be registered in a State Office such as the office of the Secretary of State. 

Importance of Picking the Right Business Entity

Choosing the kind of business entity is a key decision that owners must encounter when first starting a business. Each type has its pros and cons, and depending on the business’s type, number of owners and other goals, the ideal type may vary. 

Choosing the right kind of business entity can shield your personal assets in case of financial or legal burden, even if your business assets may be under fire. Hiring a local business attorney who’s experienced in helping their clients make beneficial business decisions will help new business owners choose their business entity type. 

What to Consider When Determining a Business Entity

  • Tax Treatment

A C corporation has to pay not only state and federal taxes, but the owners are separately taxed for the income they make from the C corporation. When it comes to an S corporation or an LLC, the taxes rely solely on the amount of money the owners of said companies are taking home from the business. These business entities can be subjected to self-employment taxes. 

  • How Capital is Raised 

How capital is raised for a company is regulated by the type of business entity it’s registered as. C corporations, as well as S corporations, have a large amount of flexibility when it comes to how they can acquire their capital, as opposed to partnerships, where how the capital is raised is highly regulated. 

  • Ownership and Management Structure

Corporations, LLCs, and limited partnerships separate ownership from management, limiting the owner’s vulnerability. In sole proprietorships and partnerships, however, the owner can be held personally responsible for management decisions. 

  • Transfer of Ownership

C corporations and S corporations make the transfer of ownership very easy, as ownership is based on shares held by shareholders. Partnerships, on the other hand, have to be terminated. Sole proprietorship businesses must be sold to transfer ownership. 

  • Ease of Formation

Sole proprietorships are the easiest to form. Sometimes they don’t even requiring registration, depending on the state. Other types of business entities must be registered at a State Office and need to adhere to a set of recordkeeping rules to retain limited liability protections, which can be costly and time-consuming. 

Written by:

Stuart MacPherson

Hi, I'm Stuart. I've been running my own small business since 2019 after leaving a successful career in finance. I created FranchiseTheory to share my enthusiasm for franchising and the franchise business model.

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