Let’s start with the basics. Before we can get into what type of entity you should form, let’s take some time to break down what an entity is and why you should form one. Simply put, an entity is an organization created by one or more people for the purpose of carrying on a business. While it is possible to conduct business in your personal capacity, in most cases, it is strongly advised to create an entity, separate from yourself, when conducting business.
One of the most important reasons to create a separate business entity is so that you are protected from personal liability for the acts of the business. For example, if your company becomes the subject of a personal injury claim and you did not create a separate entity for your business, the plaintiff can come after your personal assets as well as the assets of your business. However, if you created a business entity and properly maintained the distinction between yourself and your business entity, the plaintiff can be restricted to only the assets of the business.
Another reason to create a business entity is to simplify management and governance of the business organization. A business that involves more than one person means there will be ownership shares and rights particular to these persons, and it is much easier to have an organizational document that stipulates the rights and responsibilities of owners as opposed to having separate and complicated contracts to define the relationships between the parties.
Also, entity formation is pretty much a requirement if your business intends to raise outside capital. The business entity facilitates this by lumping all of the business assets and liabilities into the organization instead of having to deal with the finances and claims of everyone who might be involved.
Lastly, business formation provides you with an air of professionalism in dealing with the public. It gives the public some confidence in your business at the outset when they know they are dealing with a company that really exists.
So, now you know what business entities are and why you need one. Let’s take a closer look at the various entity types and analyze the differences between them.
As a business owner, you have quite a few options as to how you can structure your business. You should consult an attorney about the details of your business, including the products and/or services you will be offering, the owners of the business and their roles, projected income and expenses, and the overall goals of the business, so that you can be advised as to which business structure is right for you. We will briefly discuss the main entity types below.
A partnership is an association of two or more people carrying on a business for a profit. This is the easiest and cheapest legal entity to set up. Partnerships are created by default whenever two or more people go into business together without setting up a formal legal entity with the Secretary Of State. They are created by express, oral or implied terms between the parties. Without a written agreement to the contrary, partners share equally in the management and control of the partnership. Each partner contributes property, time, skill, money or some contribution to the partnership. Partners also share equally in the gains and losses of the partnership, and they are jointly, severally and individually liable for the debts and liabilities of the partnership unless otherwise stipulated in writing. This means that a person suing a partnership, can go after one or more partners and also reach their personal assets outside of the partnership. This entity offers no protection from liability.
Corporations are governed by state law and statute. They are created by filing Articles of Incorporation with your Secretary of State (“SOS”) and paying the associated fees. Depending on your state, other documents may need to be filed with the SOS as well, so you must check your state’s requirements to be compliant. Generally, corporations are owned by its shareholders, governed by its Board of Directors and run by its officers. The Shareholder’s Agreement is an internal document that governs the corporation and includes information regarding the purpose of the corporation, ownership shares, voting for new members officers and the Board, capital and contribution, allocation of profits and losses, roles and duties of officers, shareholders and the Board, and dissolution. In addition to the Shareholder’s Agreement, the corporation must have employment agreements between the corporation and those employed by the corporation.
Limited Liability Company
Limited Liability Companies (LLC’s) are created by filing Articles of Organization with your SOS and paying the associated fees. Depending on your state, other documents may need to be filed with the SOS as well. LLC’s are owned by its members and run by its managing member. The Operating Agreement is an internal document that governs the LLC and includes information regarding the purpose of the LLC, membership voting, selection of managing member and his duties, adding and removal of members, capital and contribution, allocation of losses and profits, and dissolution. The main advantage of an LLC is limited liability for its owners, meaning that the members are not individually responsible for the debts of the company. LLC’s are the preferred entity for small businesses because they are less expensive to set up and operate than corporations and offer the same benefits of limited liability. The management of the LLC is much more flexible, and it is much easier to maintain the separation between individual and entity, so the corporate veil is less likely to be pierced with this legal entity. LLC’s also provide the additional benefit of flow through taxation.
Lerae Funderburg, Esq. is the Managing Attorney at Funderburg Law, LLC, an Atlanta based law firm specializing in entertainment and business transactions and estate planning. As a lawyer and blogger, Lerae keeps her viewers and subscribers up to date with legal news, especially in the areas of business, estate planning, music, film, copyright law and trademark law. If you are local to Atlanta, call and set up a consultation! She would love to hear from you!