Choice of Entity

What a lawyer is referring to when he talks about the "choice of entity" is the legal form which your business will take. As you probably know, there are legal creations which allow a business to take on an existence apart form its owners, even though the owners still control the business. Corporations and partnerships were the two traditional legal entities that allowed this, but that list has grown longer to include limited partnerships, limited liability companies, and Subchapter-S corporations.

Why is the type of legal entity you chose for your business important? Because owners can be liabile for tax liabilities and tortious (think slip and fall) injuries caused by their business. Whether the owner is then personally liable for such liabilities of the business often hinges on the type of legal entity chosen. What this means is that depending on the type of entity you choose, you (the owner) could be personally sued (as opposed to just your business being sued) by the government or private parties when things go wrong and people are looking to get money out of someone. With the proper choice of legal entity, you can worry less about such a thing happening (law, being an uncertain science, can never promise you that there is nothing to worry about).

Don't Perform Your Own Brain Surgery

Suffice to say that deciding on what type of entity to use is one of the more important decisions you face as the owner or promoter of a new business. The ability to sell your ownership interest in a business, the ease of later capital infusions, the relationship between co-owners, and, of course, liability for the business's tax or legal problems are all dependent upon the choice of entity. DO NOT TRY TO READ YOUR HOME STATE'S STATUTE CONCERNING THE CREATION OF BUSINESS ENTITIES AND ASSUME THAT THAT WILL BE ENOUGH TO INFORM YOU ABOUT WHICH ENTITY TO CHOOSE! You would never fool yourself into thinking that by boning up a little on surgical techniques, you could perform an operation on yourself. Do not make the foolish error of thinking a business lawyer's job is somehow easier than other professions which take years of study and practice; you will only be creating costly and potentially ruinous problems for yourself down the road.

Do your business a big favor. Hire a lawyer to help create it--those legal midwives can help you avoid mortally harming your business during one of its most crucial periods: the beginning.

What factors go into the Choice of Entity?

Every single fact concerning your business is relevant to the Choice of Entity decision. Not all of them are of equal importance, but they all matter to some degree.

For almost all start-up companies, the considerations that should be in the forefront are not the sale of ownership interests to the public or venture capital financing--these things come later (hopefully!). Instead, the initial focus should be on:

  • the tax and tort liability issues,
  • cost of maintenance of the entity,
  • protection of intellectual property (very important and often overlooked),
  • size and complexity of the entity,
  • regulatory requirements that the local, state or federal government has placed on the proposed business activity,
  • and other similarly mundane issues.

These are much more relevant to a young business, albeit less exciting than "going public" or getting venture capital money. Still, success depends upon them. Please pay attention to your choice of entity at some point, it really does make a very large difference later on.

Here is a list of standard business entities. Each one is a link to some basic information about the particular entity.

  1. C-Corp
  2. Limited Partnerships and Partnerships
  3. Sole Proprietorship
  4. S-Corporation
  5. Limited Liability Companies