How to Choose the Right Business Entity

Choosing the right business entity allows an entrepreneur to reduce liability exposure, minimize taxes, and ensure that the business can be financed and run efficiently. It also provides business owners with a mechanism for ensuring that the business operations will continue, rather than being automatically terminated, upon the death of an owner. Formalizing the business also clarifies the ownership of all participants in the venture.

When choosing a business entity, you should consider: (1) the degree to which your personal assets are at risk from liabilities arising from your business; (2) how to best pursue tax advantages and avoid multiple layers of taxation; (3) the ability to attract potential investors; (4) the ability to offer ownership interests to key employees; and (5) the costs of operating and maintaining the business entity.

Despite the implication in this article's title, you should not approach this subject with the idea that there is only one entity type that's right for your business. The choice you make will inevitably involve weighing the advantages and the disadvantages of several factors that apply to your particular business. You should also keep in mind that there will inevitably be various changes in the nature of your business over time, and these changes may make it more advantageous either to change your entity type or its tax classification. With that in mind, let's take a look at the main entity types that are available.

The availability of a particular entity type initially depends on the number of owners. A single owner may operate as a sole proprietor, a corporation, or a limited liability company. If there are two or more owners of the business, by definition it cannot be a sole proprietorship, but it can be a corporation, limited liability company, general partnership, limited partnership, or, in certain situations, a limited liability partnership.

We'll first review the entity choices available for a single business owner.