When it comes to business, any one factor or change of circumstances can mean the difference between turning a profit and suffering a loss. One of the most consequential early decisions is the choice of business entity. At Poulson Law, we have experience forming domestic and foreign corporations, limited liability companies, partnerships, and joint ventures.
Why Entity Choice Matters
The entity you choose affects liability protection, taxation, and governance flexibility. These three areas shape every aspect of how your business operates and how profits flow to owners.
The Main Entity Types
Sole Proprietorship
Not a separate legal entity — simply an individual doing business. No liability protection; personal assets are at risk. Appropriate only for very small, low-risk businesses.
General Partnership
Formed when two or more people carry on a business for profit as co-owners. No liability protection — each partner is personally liable for all partnership debts. Should generally be avoided in favor of limited liability entities.
Limited Liability Company (LLC)
The most popular entity type for small and mid-sized businesses. Combines liability protection with tax flexibility. Governed by an operating agreement that can be highly customized. LLCs are not required to hold formal meetings or maintain minutes.
C-Corporation
A separate legal entity providing strong liability protection. Standard for publicly traded companies and businesses seeking venture capital. Subject to "double taxation" — the corporation pays tax on income, and shareholders pay tax on dividends. The 2017 tax law reduced the corporate rate to 21%.
S-Corporation
A tax election available to corporations and LLCs that provides pass-through taxation while maintaining liability protection. Subject to restrictions: maximum 100 shareholders, U.S. citizens only, one class of stock. Unsuitable for businesses seeking institutional investment.
Limited Partnership
Has general partners (manage the business, unlimited liability) and limited partners (passive investors, liability limited to investment). Commonly used in real estate and investment fund structures.
Key Factors in Choosing
Liability Risk
If your business involves significant liability risk, the liability protection of an LLC or corporation is essential.
Tax Considerations
Pass-through taxation is generally preferred for businesses where owners want to access profits directly. C-corporation taxation may be preferred for reinvestment or venture capital.
Investment and Capital Needs
If you plan to raise capital from outside investors — particularly venture capital or private equity — a C-corporation is typically required.
Management and Control
LLCs offer the greatest flexibility in management structure. Corporations have a more rigid governance structure but may be preferable for formal governance.
Questions to Answer Before You Form
Do You Have a Business Plan?
One of the most crucial parts of starting a business is having a business plan that will dictate how you intend to operate and make money. This is not only important for your sake; having a business plan is a critical component for attracting financing and planning your steps as you form your company. What you lay out in your business plan will set your requirements for every other step in forming your business.
Do You Have the Appropriate Licenses and Permits?
There are few industries that do not have some type of regulations dictating how they must carry out their business. To that end, you need to make sure you meet all local, state, and federal licensing and permitting requirements to start your business. If you do not, you could find your company hindered by serious legal and financial troubles before you have even begun making money.
Can You Meet Your Company's Formal Legal Requirements?
Different types of businesses have different legal requirements to start up. A partnership, for example, is relatively simple, while a corporation has strict requirements about shareholder meetings, board meetings, and management of finances. You need to be able to handle your company's formal legal requirements, or else face potential consequences if your company is ever brought to court.
The Formation Process
- Filing formation documents with the Secretary of State
- Preparing governance documents (bylaws or operating agreement)
- Obtaining an EIN from the IRS
- Registering for state taxes
- Obtaining licenses and permits
- Opening a separate bank account
Common Mistakes to Avoid
- Choosing an entity without considering tax implications
- Failing to maintain corporate formalities
- Not having a written operating agreement
- Commingling personal and business funds
Frequently Asked Questions
Can I change my entity type later? Yes, but it can be complex with tax consequences. Better to choose correctly at the outset.
Should I form my entity in Delaware? Delaware is popular for corporations seeking investment. For LLCs, your home state may be more appropriate.
Do I need a lawyer to form an entity? The real value is in governance documents and choosing the right entity type. The cost of getting it wrong far exceeds the cost of experienced legal counsel.
Start Your Business Right
The business law attorneys at Poulson Law will work closely with you to form a legal strategy that best suits your needs. Contact us at 607-547-1195.
