Types of Business Entities And Their Advantages and Disadvantages

Types Business Entities

Before you start a business, you need to choose the type of business entity that perfectly suits your requirements and the kind of business you are planning to start. A business entity is the legal business organization required to conduct business officially in an area. There are many reasons why you need to register your business as a legal entity. It not only provides you personal protection but also it defines the taxes to be paid by your organization, the kind of partnerships you can form, and the way your business will function and by whom.

There are 5 basic types of business entities as follows:

1. Sole Proprietorship
2.Limited Liability Partnership
3.Limited Partnership
4.Limited Liability Company (LLC)
5.Corporation

Sole Proprietorship

A sole partnership needs not to be registered officially. A person conducting a business and having no partner is the sole proprietor. It is the simplest type of business entity. These businesses can still hire employees and external help but cannot have more than one owner.

Advantages of Sole Proprietorship

  • There is no cost of the establishment as you can work from anywhere if your business is not registered.
  • No tax liability
  • The cost of forming such a business is zero.

Disadvantages

  • All the risks and liabilities are borne by the owner of the business.
  • No legal protection for the business.
  • Investors and creditors are able to collect their dues against the person or business property of the owner.
  • Getting loans is not easy.

Limited Liability Partnership

Some professional businesses and companies can form limited liability partnership (LLP) with one or more persons. In this kind of partnership, the liability of each of the business partners are limited to the company and a few other things, but not on the personal activities of other partners. A business needs to be registered as LLP with the local or state registrar to be eligible for the benefits.

Recommended Reading: How to Build a Good Partnership without Ruining the Relationship

Advantages of LLP

  • A business partner is not responsible for the wrong/illicit activities of other partners.
  • An LLP is a tax pass-through entity, that means all the tax liability are divided among the partners of the business.
  • Registration of LLP is cheaper.
  • There are fewer rules associated with it.
  • It is comparatively easier to exit an LLP partnership.
  • No upper-limit on the number of partners.

Disadvantages of LLP

  • Requires minimum two partners.
  • Fundraising options are limited.
  • Less business credibility
  • In some countries, LLP can only be formed by professional service providers including lawyers, accountants, and doctors.

Limited Partnership (LP)

A limited partnership firm has both regular partners and limited partners. A regular/general partner is responsible for managing the day-to-day tasks and management responsibilities of the business, while the limited partners are liable only to make their part of capital contributions, as and when required. A limited partnership is required to have at least one regular partner. This type of partnership works great in the real estate and other related businesses where the general partner can get tax and investment benefits by forming an LP.

Advantages of LP

  • Less paperwork and formalities than a corporation
  • An LP is not liable to be taxed but individual partners have to file expenses in their personal income tax returns.
  • A partner is only liable for his own debt equal to the amount he invested in the business.
  • The limited partners do not have any role in the management and decision-making process.
  • The limited partner can leave anytime without dissolving the partnership.
  • This is a kind of investment opportunity.

Disadvantages

  • The general partners are liable for all the risks, dues and debts of the company, as well as for the consequences of their decisions.
  • It is necessary to create a partnership agreement to define the roles of the limited partners in the company.
  • It may be essential to hold annual meetings for all the partners.

Limited Liability Company (LLC)

An LLC is the type of business entity where the liability of the company is limited. It is usually owned by one or more people. It provides protection to the owners as they are not personally liable for the debts and dues of the company. Same as every other partnership, an LLC is formed by registering your partnership with the legal office and signing an LLC operating agreement.

Advantages

  • It is a better alternative to LP, as it doesn’t involve any personal liability to business owners.
  • It is inexpensive to form.
  • LLC is owned by all the partners, and they can decide on how business profits, losses, shares, and management responsibilities will be shared.
  • These are usually good for real estate partnerships.

Disadvantages

  • No or less prospect of investors
  • Doesn’t work for a complex business structure.
  • As one of LLC partners, you cannot pay yourself for the work.

Corporation

A corporation is the top type of business entity. It is usually owned by the company shareholders and managed by a board of directors, which is also formed by the shareholders. The board is responsible for making all the important business decisions and firing/hiring officers in the company.

Advantages of a Corporation

  • The ownership is transferable based on who has the most shares at a given time.
  • It gives you the ability to make public stock offerings and acquire capital.
  • Generally, business shareholders and employees are not liable for the company’s debts and obligations, while shareholders will only lose their own investment if the business ever fails.
  • Well-established business structure with roles and responsibilities clearly defined.
  • The organization employees can receive stock benefits.

Disadvantages

  • Expensive to form and manage.
  • More paperwork and time-consuming.
  • Shareholders can only hire/fire the managers and officers but have no direct control in the managerial process.
  • Tax is charged on the corporation as well as on the individual salaries of the shareholders, thus causing double taxation.

Read the above descriptions, pros and cons carefully, and choose the right business entity for your business.

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