Choosing the Right Entity for Business Formation

CHOOSING THE RIGHT ENTITY FOR BUSINESS FORMATION

There is no perfect entity type that accommodates any and all kinds of businesses out there. It is important to really take into consideration your business size (the number of employees), company goals, limitations and so on in order to choose the best entity for your business. Each entity has its pros and cons so it would be very wise and practical to choose the entity which best suits your business needs, as well as ensure that whichever you choose provides your company with pros that outweigh the cons.

This article will cover many aspects of the various kinds of business entities. For an at-a-glance view of the differences between legal structures, see our Business Entity Comparison Table.

CORPORATIONS

There are two general kinds of corporations: C-Corporations and S-Corporations. Both corporations require you to file formation documents with a state filing agency, but S- Corps requires additional filings. It is also required in most states for both corporations to have annual meetings and bylaws. For S-Corp you must elect “S Status” through the IRS. The required operational procedures include having a Board of Directors and Officers, annual meetings, filings and reporting.

For both types of corporations the shareholders are not liable for any debts of the corporation, but some members (or officers) can be held liable if it involves fraud or severe mismanagement. Unlike an S-Corp, whose staff size cannot exceed 75 members (or shareholders), a C-Corporation does not have any staff size limitations. Also, both types of corporations can exist for an unlimited amount of time.

There are start-up fees for both S-Corp and C-Corp entities in California: $100 + $800 annual minimum tax starting the second year. S-Corporations are taxed only once a year compared to C-Corporations where both the corporation and the shareholders are taxed.  There may also be some additional local city and county registration fees.

Examples of C-Corporations: Automobile makers, software companies, essentially most public companies

Examples of S- Corporations: Family and small businesses such as interior design companies, pizza parlors, print shops.

LIMITED LIABILITY COMPANIES

A Limited Liability Company is a business entity created by legislation that offers its owners the limited personal liability of a corporation and the tax advantages of a partnership. Just like a corporation, Limited Liability Companies need to have formation documents and an Operating Agreement document filed with the state agency. Standard operational procedures are not as extensive as corporations, but most states do have some formal requirements such as annual reports.

Members are not responsible for debts accrued by the company unless a member secured the debt with a personal asset. The size of an LLC can be single member, but there are some states where two or more members are required. LLCs can have perpetual existence unless the state agency in which the LLC is filed in does not allow for perpetual existence.  

An LLC in California cannot acquire a professional state license to operate, e.g. Contractor’s License or Real Estate License. The California Corporations Code defines such "professional services" as: "Any type of professional services that may be lawfully rendered only pursuant to a license, certification or registration authorized by the Business and Professions Code, the Chiropractic Act, the Osteopathic Act or the Yacht and Ship Brokers Act. If your business is required to be licensed, registered or certified, it is recommended that you contact the appropriate licensing authority before filing with the SOS's office in order to determine whether your services are considered professional. (California Corporations Code sections 13401(a) and 13401.3, see also the Secretary of State's LLC form instructions )

For more information about LLCs and other business entities check out our Entity Comparison Table.

Examples of LLCs: Real Estate Investment Properties, restaurants, Motion Picture Groups

SOLE PROPRIETORSHIP (SP)

No state filing is required for this kind of entity, but a City Tax License may be required. The only start-up cost for an SP in California is the Business Tax License. The kind of operational procedures required are easier to carry out and overall there are few legal requirements. SPs are taxed only once yearly. This kind of entity has unlimited liability and so personal assets can be lost.

A Sole Proprietorship can either cease doing business or die; there is no set number of years for it to exist.

Examples: arts and crafts shops, “Mom and Pop” type of shops, website developer businesses

GENERAL PARTNERSHIP (GP)

Like a Sole Proprietorship GPs usually do not require state filings- but some states allow GPs to file at state agencies. A Partnership Agreement should be created. There are few legal requirements. In terms of liability both business partners are equally responsible unless the Partnership Agreement states otherwise.

Two or more people can form a General Partnership and the length of existence depends upon the Partnership Agreement. The typical cause of dissolution is the death or withdrawal of one of the partners. The start-up costs include the business tax license and other such filings can be done at both the county and state levels.

Examples: any small businesses where there are two or more business partners working under a Partnership Agreement, such as an auto repair shop.