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Considerations to Help You Determine the Legal Structure of Your Business

Considerations to Help You Determine the Legal Structure of Your Business

Choosing the right legal structure for your business can protect your personal assets if your business is sued. It can also save you money on your taxes. Choosing a legal structure is a complex decision, and you should seek the advice of an attorney and tax professional before making a decision.

Basically, there are two broad types of business structures: those that offer their owners limited liability, and those that do not.

In limited liability entities, such as corporations, limited partnerships, and limited liability companies, the business has a separate legal existence from its owners. Generally, the owners' liability for business debts and obligations is limited to the amount they invested in the business. Owners, however, may remain personally liable for their own negligence or other wrongdoing.

Other businesses, such as sole proprietorships and general partnerships, do not exist separately from their owners. Typically, the owners are personally liable for all of the firm's obligations. A business that hasn't formed a limited liability entity will by default be considered a sole proprietorship or general partnership.

To form a limited liability entity, you must file formation documents with the state. Most small businesses file these documents in the state where their business is located, but companies sometimes file formation documents in a different state, such as Delaware, to take advantage of its corporation–friendly laws. A business lawyer can advise you on where to form your business.

Typically, a business must select a name that is distinct from other entity names in the state, pay a filing fee, and name a person or entity to act as registered agent to receive notices and service of lawsuits or other court documents. The exact information required in formation documents varies from state to state.

No matter which business entity you choose, you should have an internal agreement that specifies such things as the rights and contributions of the owners, their rights to share in company profits, how the business will be managed, the procedures if an owner dies or leaves the business, and the procedures for dissolving the business. Hiring a business attorney to prepare an agreement when you form your business can avoid costly disputes later on. Depending on where you live and the type of business you form, this agreement might be called a partnership agreement, an operating agreement, or bylaws.

Let's look at some of the possible business entity options. This section includes a basic explanation of potential legal structures, so be sure to seek legal counsel and advice from experience business owners or consultants before deciding on the appropriate structure for your business.

Sole Proprietorship and Partnership

A person who is the sole owner of a business can operate as a sole proprietorship. No paperwork is necessary to establish a sole proprietorship, but if your business is operating under a name other than the sole proprietor's name (such as ’Joe's Coffee’ or ’Intrepid Designs’) you may need to file documents with the state to establish a fictitious business name, trade name, or dba.

A partnership works the same way as a sole proprietorship except that there are two or more partners instead of one.

A limited partnership differs from a general partnership in that it has both general partners and "limited partners" who act as investors: typically, the limited partners do not participate in running the company, and their liability is usually limited to the amount they invested.

One drawback of a partnership is that the general partner is liable not only for the debts and obligations of the partnership, but also for any negligence or misdeeds of any of the other partners.

Limited Liability Company

A limited liability company, or LLC, is a legal entity distinct from its owners. In many states, LLCs are easy to set up, offer flexible management and ownership options, and have fewer ongoing reporting requirements than corporations. The owners of an LLC are called "members," and an LLC can have one or many members.

If you are a licensed professional such as an attorney, doctor, or architect, your state's laws may require you to form a Professional Limited Liability Company, or PLLC, instead of an LLC. You may be required to obtain approval from your state licensing board before forming a PLLC. A PLLC has the same limited liability as an LLC.

Limited Liability Partnership

A limited liability partnership is, as the name implies, a partnership that offers limited liability for its partners. Setting up a limited liability partnership may be as simple as filing an additional form with the state after establishing a general partnership.

Corporation or Professional Corporation

Corporations are also limited liability entities. In some states, a corporation formed by licensed professionals may be called a "professional corporation" or a "professional services corporation" to distinguish it from other types of corporations. Owners of corporations are called shareholders and enjoy several key benefits:

  • Owner-employees can participate in and enjoy tax deductions for company-paid benefit plans, including health insurance and retirement plans.
  • Shareholder liability for corporate obligations is generally limited to the shareholder's investment in the company. Individual shareholders are typically shielded from personal liability for other shareholders' or employees' wrongdoing.
  • A corporation may be eligible for flexible tax treatment. If you are interested in creating a corporation, talk to a tax professional about tax considerations.

A small business attorney can advise you of the best type of entity for your business, can handle filings with the state, and can draft an internal operating document and any resolutions that you might need.

The information included on this website is designed for informational purposes only. It is not legal, tax, financial, or any other sort of advice; nor is it a substitute for such advice. The information on this site may not apply to your specific situation. We have tried to make sure the information is accurate, but it could be outdated or even inaccurate, in parts. It is the reader's responsibility to comply with any applicable local, state, or federal regulations, and to make their own decisions about how to operate their business. Nationwide Mutual Insurance Company, its affiliates, and their employees make no warranties about the information, no guarantee of results, and assume no liability in connection with the information provided.