How To Choose The Right Entity Structure For Your Company—Part 1

By Pantea I. Fozouni

April 18, 2022

Entity structure

Your business entity structure is one of, if not the most important, decisions you make when starting a company. This significantly impacts your success or failure and affects various aspects such as taxes paid, records required to be kept, ability to finance your venture, and how exposed your personal assets are to legal/financial liabilities incurred by the company.

When you are trying to choose between the different entity types, you have to decide between a sole proprietorship or partnership (the default choices if you do nothing), corporation, or limited liability company (LLC). 

You might have noticed that we did not mention an S-corporation, B-corporation, or public-benefit corporation. That's because they're all types of corporations. A trust can be an owner of an entity, but it is not the entity itself.

The legal entity you choose for your business is important, as it will be the container for your business. This is distinct from how that container is owned (for example, through a trust) and also distinct from how that entity is taxed (which could be as an S-corporation or nonprofit).

You should always consult with us, your Family Business Lawyer™ to help you make your final decision. In this two-part series, we’ll discuss several key questions you should ask yourself when choosing the right legal entity for your particular business venture.

1. How Many People Own Your Company?

The entity structures available to you for your business are affected by the number of owners it has. For example, if you're the only owner, you can operate as a sole proprietorship, an LLC, or a corporation. If you choose an LLC and there's only one owner, it's called a “single-member LLC.” And if you choose a corporation and there is only one shareholder who owns all the outstanding stock in that company—that would be YOU!

If your business is owned by multiple people, you can choose to be a partnership, an LLC, or a corporation. If you go with the LLC route and have more than one owner, then your company would technically be considered a multi-member LLC. However, it's imperative that if you have multiple owners in your business. The parameters and responsibilities are settled with the help of professional legal counsel, so there are no issues later down the road. 

When you have more than one owner in your business, there are several factors to consider that you may overlook if you try to manage this yourself. If something goes wrong, it could cost your company dearly - even preventing a future sale or damaging relationships between members - so it's best to seek professional help from the start.

When making business decisions, you can't just rely on a one-size-fits-all type of mentality. Instead, you have to take into account the unique circumstances of your business, such as ownership terms and transfer rights. What happens when a member wants out, or an owner dies? These are important questions that require serious consideration. 

If you forgo professional help and attempt to draw up your own business agreements, you run the very real risk of costly and detrimental surprises later down the road--for example, if you sell the business, one of the owners dies or wants to leave, or when trying to raise capital.

Given these risks, it's crucial that you seek legal assistance no matter what type of entity you choose. We, your Family Business Lawyer™, can assist in getting your company's key agreements in place.

2. How Much Of Your Personal Assets Are You Willing to Put at Risk?

The second deciding factor in your entity choice is protecting yourself and your company from legal liability. All businesses should understand that they will likely face some sort of legal conflict or dispute at one point or another due to our current societal climate. This could be something small, such as a customer asking for a refund, or it could be more serious, like an employee filing a lawsuit against the business. Unfortunately, it could also always be worse than either of those examples. If your business is sued and you don't have the right legal entity set up, you could lose your home, car, and life savings.

In the event your company faces bankruptcy or a lawsuit, you could lose your personal assets if you don't have the right entity in place. This is because, without the proper precautions, there is no separation between your business and personal belongings. Consequently, your creditors could seize your house, car, or other valuables to repay what you owe. Avoid this outcome by taking measures to protect yourself early on.

For example, if your company is a sole proprietorship or partnership, you and the other owners would be held legally responsible for any debt or court judgment against the business. This is because in the eyes of the law, your business and its owners are considered one entity.

You can protect your personal assets by setting up your business as an LLC or corporation, which establishes the company as a separate legal entity from you and other owners. This way, you are not held personally liable for corporate debt or judgments if they are properly maintained.

We are your Family Business Lawyer™. Not only will we help you decide on the best entity for your business, but we will also establish and manage it efficiently to make sure you have optimal personal liability coverage throughout the life of your enterprise.

Join us next week to explore the additional risks you should consider when selecting your business entity.

This post forms part of our Small Business Series and to access the other in-depth articles, please visit the links below.

7 Tips For Creating A Winning Business Plan
How To Choose The Right Entity Structure For Your Company—Part 1
How To Choose The Right Entity Structure For Your Company—Part 2
How to Grow Your Business for Sustainable Success in 2023
5 Best Practices For Establishing Healthy Boundaries With Clients
6 Essential Strategies For Starting A New Business
Putting Your Kids On The Payroll Can Benefit Your Business AND Help You Save Big Money On Your Taxes
3 Red Flags To Watch For When Dealing With Problem Clients
5 Strategies For Boosting Your Startup Business’s Cash Flow

Here at Palm Desert Law Group, we want to help you make the best choices for your family business, whether that be throughout its life or in the event of death. We offer a wide range of legal services and LIFT Start-Up Sessions™ or LIFT Audits for businesses already established. During these sessions/audits, we will go over all aspects of your business from a legal, financial, and tax standpoint. Give us a call today to schedule an appointment!

At our law firm, we want to help you make the best decisions for your business not only during its life cycle but also after your death. We call this comprehensive service LIFT: Your Life And Business Planning Session. During this session, we will go over all of the important legal, insurance, financial, and tax details regarding your business. Schedule online today.

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