We are often asked “what is the best entity type?” There really is no one-size-fits-all answer because each entity may be more or less beneficial for any given enterprise. Rather, it is important for entrepreneurs to consider various factors when choosing a business entity.
The entity type should not dictate the plans for the business. Rather, entrepreneurs should pursue their goals and find the entity type that fits their plans. Below are a few important factors to consider when choosing a business entity.
The first factor to consider when choosing a business entity is limited liability. Without limited liability status, creditors of the business can access the personal assets of the business owners. Choosing the right entity type will limit personal liability for the owners of your business up to the extent of their investment. Limited liability is often thought of as the primary reason for establishing a “formal” business entity (i.e. a business entity that requires filing paperwork with a state).
Moreover, in a partnership without limited liability, all partners are jointly and severally liable for the acts of the other partners. This means that if one partner acts negligently, the personal assets of all other partners may be reached to satisfy the liability.
If you plan to seek private equity funding for your business (such as angel investment, venture capital, or other forms of equity funding), then the corporate form will likely be preferred by investors. While it is certainly possible to structure LLC distributions in a way that mimics corporate shares, equity investors tend to be more comfortable with the corporate form for several reasons.
First, LLCs can be structured in many ways and the governing documents of an LLC can be changed to alter the structure. But corporate shares are governed by statute and, therefore, give more predictability to investors.
Second, corporate shares are generally considered to be a more liquid asset that is easier for an investor to transfer.
Third, investors are simply more familiar with corporate share transactions based in part on the fact that there is significant case law governing corporate transactions and much less law surrounding LLC ownership interests.
If you plan to establish a social enterprise that will seek impact investment (i.e. investment from sources seeking a measurable social or environmental benefit in addition to a financial return), setting up your business as a benefit corporation or flexible purpose corporation can help to demonstrate a commitment to a social and/or environmental mission. Similarly, if you plan to market your products or services to socially responsible consumers, incorporating as a benefit corporation or flexible purpose corporation demonstrates your commitment to conducting business for a greater good beyond profits.
Each entity type has various formalities imposed by statute that should be considered when choosing a business entity. These range from practically no formalities in the case of sole proprietorships and general partnerships to extensive ongoing requirements required of corporations. The formalities imposed on various entities include, for example:
The LLC is often thought of as the entity that provides the most flexibility in terms of formalities while still enjoying limited liability.
This article was contributed by our friends at Elevate Law and Strategy. Contact them to discuss these factors to help you choose a business entity that best fits your goals.