Control. Flexibility. Protection from liability. Options for investors. All of these factors and many others play an important role in choosing the right business entity for your business. Choose the wrong entity type and you could be subjected to unnecessary regulations and reporting requirements or expose yourself to too much liability.
Each entity type has advantages and disadvantages. Which one is right for your business depends largely on the sort of business you have and what you want to achieve with it. We have found that for most small businesses in Ohio, the limited liability company offers the most flexibility and protection from liability for owners. But before selecting a business entity, you need to ask yourself some important questions, such as:
How much control over your business do you need to have? Do you need total control, or are you willing to share control and responsibilities with partners or a board of directors?
How much risk for liability is involved? What are the dangers to your personal financial situation?
Do you need to take on investors or want to share business interests with family members? What level of control are you willing to share with investors or family and what level of risk are they willing to take on?
Do you want your business to survive and thrive after you’re gone so others can continue to benefit from it?
When working with a client to choose a business entity, we look at many more considerations, but these will get you started. After answering those questions, you can begin to compare entity types in a meaningful way.
Five types of business entities are available to Ohio businesses. Below we’ll briefly examine sole proprietorships, general partnerships and limited partnerships. They are popular as small business entities because they are the simplest and least expensive to set up, and they don’t have the complicated reporting requirements that other entity forms have. In our next two articles, we’ll tackle the other types of entities: limited liability companies and corporations.
Sole proprietorship is the simplest form of business entity. The owner makes all decisions themselves and is answerable only to himself or herself, giving him or her the highest level of control. But it is also has the highest risk level as the owner personally assumes all risk of liability. The owner is also subject to self-employment tax and must invest his or her own money or secure their own financing for any capital needs as there are no shares to sell to outside investors. Lastly, there is no means to transfer ownership of a sole proprietorship as a whole. Equipment and property may be sold or transferred, but not the business as a whole. When the owner of a sole proprietorship retires or dies, the business terminates.
A general partnership is essentially a sole proprietorship with more than one owner. All partners share operational control and liability equally, though specific responsibilities and decision-making powers can be controlled somewhat through a partnership agreement. Capital must be raised by the partners personally with no ability to sell shares to investors, and the partners are subject to self-employment tax. As with a sole proprietorship, death or retirement of one partner terminates the business. It is important to note that since all partners are personally liable for the business’s debts and all partners have the ability to make promises and incur debts on behalf of the business, every partner runs the risk of being personally liable for a debt incurred by another partner.
A limited partnership includes two types of partners, general partners and limited partners. General partners are just like partners in a general partnership, sharing equally in control of the business and its liabilities. Limited partners DO NOT have control over the business and their risk is limited to loss of their financial investment. Limited partner interests may be sold as shares to investors to raise capital without affecting the business. Family members can be made limited partners so they can share in business profits without giving them management control.
There are formal requirements to form a limited partnership, along with reporting obligations. Sale or transfer of business interests are subject to securities law regulations. Business profits are taxed as income to the individual partners and general partners may also be subject to self-employment tax. Death, retirement or withdrawal of a general partner, but not a limited partner, terminates the partnership.
In our next article, we’ll examine limited liability companies so you can see the advantages and disadvantages of this highly flexible option and compare it to the entities described above. Go there now.
Get help structuring your business to fit your goals and needs
In Ohio, the business planning attorney’s office of Gudorf Law Group, LLC, can assist in identifying and setting up the ideal business entity for your company, reduce your exposure to liability, and create opportunities to share business profits with family members or take advantage of outside investors without surrendering control of your business. Call our office at 1-877-483-6730 to schedule a free consultation.